Franchising holds a special position in competition law. It is inherent to a franchise formula that the franchisor protects its accrued knowledge and intellectual property rights and monitors the uniform image of the formula. Such protection may be in breach of competition law, in particular the cartel prohibition laid down in Article 6 of the Dutch Competition Act (Mededingingswet) and Article 101 of the Treaty on the Functioning of the European Union (TFEU).
Franchise agreements therefore regularly give rise to civil actions, in which a party relies on the nullity of contract agreements on the grounds of competition rules. Franchisors and franchisees furthermore run the risk of high fines being imposed by the competition authorities in the event of (serious) breach of the cartel prohibition (see, for example, this decision and this judgment in the Netherlands). The main competition law aspects of franchise agreements are addressed in this blog.
Franchise agreements may fall within the scope of the cartel prohibition, which prohibits agreements or contacts between companies that may appreciably restrict competition. It follows from European case law that provisions of franchise agreements that are necessary to protect (i) the franchisor’s know-how and (ii) the identity and reputation of the franchise network are not in breach of the cartel prohibition. A generic Block Exemption from the cartel prohibition furthermore applies to franchise agreements, as well as other distribution agreements. It is apparent from the Guidelines that, in principle, a franchise formula necessarily imposes various obligations on the franchisee, such as:
- the obligation to refrain from competitive business operations;
- the obligation to refrain from disclosing know-how to third parties;
- the obligation to give notice of experience gained and to grant other franchisees a licence on the resulting know-how;
- the obligation to give notice of and/or take action against any infringements of the intellectual property rights; and
- the obligation to refrain from transferring rights and obligations under the agreement to third parties without the franchisor’s prior consent.
It is also apparent from European case law that the franchise formula also necessarily imposes various other obligations on the franchisee, such as:
- the obligation to sell products only in premises that meet certain requirements;
- the obligation to stop using the name and trademark immediately upon leaving the franchise network;
- the obligation to refrain from selling products under the franchisor’s name and/or trademark to distributors outside the franchise network; and
- the obligation to request approval for advertising material.
If a franchise agreement (or a clause in the agreement) cannot benefit from the Block Exemption or is not considered essential to the franchise formula, that does not necessarily mean that the franchise agreement is in breach of the cartel prohibition. It must first be proven that the agreement had the object or effect of (appreciably) restricting competition. A good example is the recent dispute between Dutch supermarket formula Jumbo and several of its franchisees regarding the validity of a non-compete clause.
Selective or exclusive franchise
Franchisors often want to limit the number of franchisees, the territory in which they may sell the products and/or the parties to whom they may resell them. A franchisor may, for instance, agree with a franchisee that it will be given the right to exclusively supply to a specific customer base in a specific territory. A franchisor may furthermore select its franchisees on the basis of “certain criteria”, which is known as a selective system. That allows the franchisor to apply qualitative and/or quantitative criteria. By setting quantitative requirements a franchisor can limit the number of franchisees (e.g. by stipulating a required minimum or maximum turnover or a maximum number of franchisees).
Non-compete clause during the term of the agreement
A common provision in franchise agreements is the non-compete clause, prohibiting the franchisee from providing services or selling goods that compete with the franchise formula. In competition law this includes purchase obligations that obligate the franchisee to purchase more than 80% of its total purchases from the franchisor.
It is apparent from European case law and the Guidelines that, in principle, a non-compete clause is considered necessary to protect the franchise formula. A case in point is the Multicopy judgment in the Netherlands, in which a franchisee’s reliance on, among other things, the nullity of the non-compete clause on the grounds of its geographical scope was prohibited. A non-compete clause entered into for a period of less than five years is in any event exempt under the Block Exemption (provided that the other conditions have also been met).
Non-compete clause after termination of the agreement
Franchise agreements often also include a non-compete clause for the period after its termination. Strict conditions apply to such a post non-compete clause. In order to qualify for the Block Exemption, the non-compete clause must:
- relate to the goods or services that compete with the contract goods or services; and
- be limited to the premises and land where the franchisee worked (i.e. this judgment and this judgment); and
- be indispensable to protect the know-how made available by the franchisor; and
- be limited to a period of one year.
If a post non-compete clause is too broadly formulated or if its term is too long, it must be demonstrated that the clause may appreciably restrict competition. A case in point is the judgment of the Amsterdam Court on the post non-compete clause in the franchise agreement of the Luizenkliniek.
A permitted provision that is regularly included in franchise agreements is the location clause. Such a clause obligates a franchisee to operate from locations approved by the franchisor. The franchisee may also be prohibited from relocating. Such provisions are considered necessary to protect the franchise network.
Right of first refusal clause
Another provision frequently included in franchise agreements, particularly in the supermarket sector, is the right of first refusal, which means that on termination of the franchise agreement the location must first be offered for lease or for sale to the franchisor. In the Griffioen case the Dutch Competition Authority at that time (currently named the ACM) found that a right of first refusal did not have the effect of restricting competition. In practice, the circumstances in each individual case must be considered to determine whether a right of first refusal may restrict competition. In light of the strict burden of proof, that will not easily be assumed.
Vertical price fixing
It is a basic principle of competition law that all companies must determine their own price policies. One of the hard core restrictions of the Block Exemption is therefore the direct or indirect imposition by a franchisor of a fixed or minimum resale price on its franchisees (resale price maintenance or RPM). Such clauses are also not considered inherent to the franchise formula. The Amsterdam Court, for instance, issued a ruling to that effect in a dispute on the price agreement (to avoid price dumping) in the franchise agreement of the City Box storage provider.
However, a franchisor may apply maximum prices and recommended retail prices (provided that they do not have the same effect as fixed or minimum prices due to pressure exerted by the franchisor). One relevant exception applies: a franchisor may apply a fixed resale price in marketing campaigns. A franchise formula may, for instance, require a coordinated short-term low-price campaign. Such a campaign is also in the interest of consumers. But such a campaign may not last too long; the European Commission applies a period of two to six weeks. A statutory exemption for a maximum period of eight weeks even applies in the Netherlands.
Products are increasingly being sold via the Internet. Competition law is based on the principle that all distributors must be able to make unrestricted use of the Internet to sell products. Nevertheless, a franchisor may obligate its franchisees:
- to refrain from active sales efforts in other regions or countries (if they have been allocated by means of an exclusive or selective system);
- to sell products from at least one brick and mortar point of sale;
- to offer online after sales services; and
- to ensure that their websites meet certain quality requirements.
A franchisor may in no event obligate its franchisees:
- to block websites for customers from other regions or countries;
- to refer customers from certain regions or countries to another trader;
- to terminate transactions of customers using credit card data from other countries;
- to limit sales via the Internet to a certain maximum; and
- to pay higher prices for products sold online.
Franchisors and franchisees are well advised to check their franchise agreements, for example by a lawyer specialised in the area of competition law, to avoid unpleasant surprises in the future.
For any information about inspections from the ACM and the European Commission please visit invalacm.nl