Business climate and recent developments
What is the extent of franchise business in your jurisdiction, including any particular franchise-heavy sectors and notable recent developments?
In 2016, the number of franchise systems in Germany has totalled 950, with nearly 120,000 franchise partners operating 160,000 businesses with almost 700,000 employees. Sales amounted to almost €104 billion in total, 4.8% more than previously. The number of companies and franchise partners has increased substantially over the past 10 years. Systems operating in the services sector represent the largest group (39%), followed by retail (30%) and the food service sector (22%). The remaining 9% operate in the skilled crafts and the construction and renovation sector (source: German Franchise Association).
Are there any franchising-specific laws in your jurisdiction? What other legal regimes apply?
There is no codified franchise law in Germany – that is, there are no specific legal provisions governing a franchise contract. However, some general contract law provisions apply. Franchise law is thus largely dominated by court decisions. In franchise disputes, the courts resort to general provisions of the law of obligations and form analogies to other types of contract (eg, commercial agency). Provisions of the Commercial Law Code, consumer protection laws, licence and IP laws, company law, as well as competition and anti-trust laws, are taken into account as well. EU law is also directly applicable, such as the Block Exemption Regulation (330/2010) and a revised set of accompanying guidelines on vertical restraints.
Is there a legal definition of ‘franchise’?
There is no legal definition of what ‘franchise’ is in Germany. However, there is a common understanding that the term describes a cooperative distribution system between an existing company (the franchisor) and one or more company founders (the franchisees). There is also an agreement that the granting of rights of use to a trademark is an indispensable element of a franchise. The Code of Ethics of the European Franchise Federation, which has been adopted by the German Franchise Association, defines ‘franchising’ as:
“a system of marketing goods and/or services and/or technology, which is based upon a close and ongoing collaboration between legally and financially separate and independent undertakings, the Franchisor and its individual Franchisees, whereby the Franchisor grants its individual Franchisee the right, and imposes the obligation, to conduct a business in accordance with the Franchisor's concept.”
Are there any specific regulatory implications for foreign franchisors seeking to expand into your jurisdiction?
Are any regulatory reforms envisaged or underway that affect franchises?
The EU General Data Protection Regulation (2016/679) will enter into force on May 25 2018 in all EU member states, including Germany. This regulation will harmonise the right to the protection of personal data and the free movement of personal data throughout Europe. Franchise systems that collect and use personal data are subject to these requirements and will be subject to substantial fines in the event of infringement. The introduction of specific legal provisions on the franchise agreement is a matter of constant discussion in Germany. A research project of the Federal Ministry of Justice and Consumer Protection launched in 2015 and comparing internationally legal regulations on franchise agreements (with a focus on the franchisor’s pre-contractual information obligations) has not yet been completed. Reservations exist within the franchise community as to the introduction of specific legal regulations.
Which models and company forms are commonly used for franchises in your jurisdiction? Are there any restrictions or requirements as to which models and forms may be used?
Most franchisors are organised either as a limited liability company (GmbH) or as a stock corporation (AG), some also as GmbH & Co KG (a limited partnership (KG) in which the general partner (Komplementär) is a GmbH. In most cases, franchisors grant their franchises to individual franchisees as natural persons. Those are then given the right to establish an operating company (usually a GmbH) in which they themselves must hold at least a majority stake and for which they assume responsibility as managing directors. The franchisee will then be allowed to operate the franchise operation through this operating company, but without necessarily becoming a contractual partner him or herself. In any case, franchisors require the franchisee to remain fully liable and responsible as a natural person, at least in addition to the operating company.
Are there any national or regional franchising associations? If so, is membership mandatory and what operational codes and guidelines apply?
The franchise industry’s interests in Germany are represented by the German Franchise Association. Membership is voluntary for franchise systems. In 2017 the association had 212 members, including 105 full members, 104 associated systems and 63 associated experts (‘suppliers’). Members and associated experts must follow the rules of the association’s Code of Ethics and comply with the quality standards defined by it.
There are numerous other industry associations of which the individual franchise systems can become members and in which their respective industry-specific interests are represented.
Common features and contractual requirements
What are the common elements of franchise agreements in your jurisdiction? Do any requirements or restrictions on contractual provisions apply?
In principle, contracts in Germany are subject to the autonomy of the parties – that is, the contracting partners are free to determine the basis of their contractual relationship themselves. Exceptions to this rule are provisions considered immoral or against the public order. Further, the provisions of franchise agreements must not violate these provisions of the German Civil Code that deal with general terms and conditions (ie, standard terms). As contracts that are frequently used in identical form, franchise agreements are usually subject to these statutory provisions, according to which, for example, lack of transparency, ambiguity or gross disadvantage of one contracting party may result in the invalidity of the clause in question when challenged in court.
Typically, franchise agreements in Germany contain provisions and corresponding annexes covering at least the following aspects:
- subject of the franchise;
- granting of rights of use;
- territory/territorial protection;
- contract term and renewal;
- preparation and opening of the franchise operation;
- obligations of the franchisor;
- obligations of the franchisee;
- courses and training;
- advertisement and marketing;
- know-how transfer and further development of the system;
- purchasing of goods/procurement;
- confidentiality and information obligations;
- IP rights;
- non-competition (contractual/post-contractual, compensation if applicable);
- entry fee and ongoing royalties;
- control rights/audits;
- reporting and accounting;
- transfer of business;
- term/extraordinary termination;
- consequences of termination of contract;
- liability of the franchisor;
- contractual penalties;
- applicable law/place of jurisdiction/dispute resolution;
- severability clause; and
- information about the right of withdrawal.
Are parties to a franchise agreement subject to an implied or explicit duty of good faith?
Section 242 of the German Civil Code states that “[a]n obligor has a duty to perform according to the requirements of good faith, taking customary practice into consideration”. This obligation applies to all parties to a contract, regardless of its nature.
Are franchise agreements subject to any formal or documentary requirements, including registration?
There are no registration requirements for franchise agreements in Germany and there are no specific documents or forms that must be used.
What due diligence should both parties undertake before entering into a franchising agreement?
The franchisor usually requires franchise prospects to fill in a questionnaire with detailed information about their background, training and financial situation, as well as a police clearance certificate. Great importance is also attributed to personal interviews. Unlike the franchisor, whose company data and other information is usually publicly accessible, information about the franchise prospect as a private individual is usually limited to what he or she communicates and hands over to the franchisor upon request. From the franchisee's point of view, in addition to the information provided by the franchisor or publicly accessible concerning the franchise system, it is crucial that he or she be able to interview other franchisees of the system.
Are franchisors subject to pre-contractual disclosure requirements? If so, do any exemptions apply? What remedies are available to franchisees in the event of breach of these requirements?
There is no statutory duty for the franchisor to provide any pre-contractual information. However, such an obligation has developed on the basis of general legal principles of German civil law, as laid down in Sections 241 and 311 of the German Civil Code, as well as the principle of good faith laid down in Section 242 of the Civil Code. Also, there is a fairly well-established jurisprudence of German courts and recommendations by the German Franchise Association on the aspects that a franchisor must at least inform before entering into a franchise agreement.
Thus, in addition to the general principles of civil law and aspects relevant to the individual sector and system, the following considerations must be made:
- the prospective franchisee’s need to know the particular circumstances of the franchise set up, through the franchisor or other sources; and
- the franchisor’s need to know about the franchisee’s personal background, business experience and knowledge of the franchise system.
The individual requirements for the degree of disclosure may vary, but the obligation to provide information cannot be fully waived, no matter how experienced a prospective franchisee may be.
If the franchisee can demonstrate in a legal dispute that he or she has not been properly informed or that he or she has been deceived by the franchisor as to certain circumstances prior to entering into the franchise agreement, the franchisee may be entitled to a right to rescind the franchise agreement and to claim damages. This includes the right to reimbursement of the entry fee and investments made in vain. The franchisee must be able to demonstrate that he or she would not have signed the franchise agreement if he or she had been duly informed of a particular fact.
Choice of law
May the parties freely choose the governing law of the franchise agreement?
In principle, the parties to a contract in which no consumer is involved are free to determine the applicable law. However, in the event of a dispute a franchisee may well question the validity of the choice of the law of a country with which none of the parties has a direct connection, and such clause may then be declared void by the competent court. This is especially the case if the choice of law in question excludes or limits mandatory rights of one party (typically, the franchisee), which that party would have had if the law of the domicile of that party had been chosen instead.
What fees are typically charged under a franchise agreement?
Franchisors in Germany typically require payment of an entry fee, which is to be paid by the franchisee for joining the system and in return for the development and integration services provided by the franchisor. In addition, it is customary for the franchisor to charge a monthly franchise fee, which is usually based on turnover. In order to avoid that no ongoing fees are owed and that the business is not actively operated by the franchisee, most franchisors charge a minimum monthly fee that is not dependent on turnover. In addition, it is customary for franchisors to demand a certain percentage of the monthly turnover of the franchisee to be paid as a so-called ‘advertising fee’. Depending on the particularities of the franchise system and the intensity of training required for franchisees, some systems may also charge a separate fee for attending training courses.
Do franchisees have a right of renewal?
Under German law, there is no statutory right to a contract renewal, neither for a party to a franchise agreement nor in any other long-term contractual relationship. However, courts have ruled that the minimum term of a franchise agreement must be long enough to allow the franchisee's investments to be amortised. This must be considered when defining the initial term of the franchise agreement.
While there is no statutory right to renewal, franchise agreements in Germany often provide for the possibility of renewal; these clauses are designed either as an automatic extension of the initial fixed term for certain further periods of time (eg, an additional year at a time), or as an option right for the franchisee. With the option, the franchisee has the right to give notice (eg, six months before the end of the fixed term) that he or she is exercising his or her unilateral option right to extend the franchise agreement for the contractually stipulated period (eg, another three or five years). If the franchise agreement provides for such a unilateral option right, it is usually linked to the franchisor's right to refuse to give consent for renewal where the franchisee has failed to follow the standards set by the agreement or a breach of the contract by the franchisee remains unresolved.
On what grounds may a franchisor refuse to renew?
Since a franchisee’s unilateral renewal right always depends on the contractual provisions, it is up to the franchisor to list the reasons for refusing a renewal. These reasons must be sufficiently clear and specific in order to be able to ascertain whether they actually existed. Otherwise, this supposedly unilateral option right is worthless.
Typically, a franchisor will also make the exercise of the option right conditional on the franchisee's consent to the conclusion of the franchise agreement in effect at that time. Likewise, a franchisor will make its consent to the exercise of the option right to renew the franchise agreement subject to the condition that the franchisee has shown him or herself to be true to the franchise agreement during the initial term.
How are renewals of franchise agreements usually effected? Do any formal or substantive requirements apply?
There are no universally valid preconditions as to how the extension is effected. As outlined above, this may be an automatic renewal or a specific right to renew a contract. It is customary for franchise agreements to provide for a period of several months or even one year during which the franchisee must give notice of his or her request for renewal. Depending on whether a new franchise contract is then used by the franchisor, or whether the existing one remains unchanged, the renewal is agreed either by signing the new franchise agreement or by formulating a short supplement to the existing contract (with signatures of both parties) under which conditions and term the existing contractual relationship is continued.
On what grounds may a franchisor terminate a franchise agreement? Are any remedies available to franchisees in this regard?
Franchise agreements often contain a number of extraordinary reasons for termination that entitle the franchisor to terminate prematurely the agreement with good cause. Many of these reasons (eg, repeated failure to pay franchise fees, infringement of IP rights such as trademarks, failure to remedy significant defects in the operation of the business and not insignificant infringements of the instructions laid down in the franchise manual) have already been the subject of legal disputes and their effectiveness has been confirmed by the courts. However, the first precondition for an early termination with good cause on the grounds of a breach of contractual obligations is that the franchisor issues a warning notice and sets a deadline within which the alleged breach of the agreement can be cured. The franchisor is entitled to give final notice of termination only after expiry of this period without cure. In the case of other serious grounds for termination that do not amount to a breach of contract, such a notice period is dispensable.
Even if no extraordinary reasons for termination are specified in the franchise agreement, each of the parties has an extraordinary right of termination under Section 314 of the German Civil Code. This is given if the terminating party cannot be expected to continue the contractual relationship until the actual end of the contract, taking into account all circumstances of the individual case and weighing up the interests of both parties.
If a franchisor terminates the franchisee prematurely with extraordinary cause, the franchisee may take legal action against this termination on the grounds that there is no good cause or that the formalities of termination have not been complied with, or that the clause provided for in the franchise agreement is invalid. The courts will then examine whether:
- the grounds for termination provided for in the franchise agreement in question have been effectively agreed; and
- the exercise of termination is justified in the particular circumstances, taking into account the interests of both parties.
If a court of law finds that this is not the case, the franchisee is entitled to claim damages from the franchisor, and the franchisee may request that the franchisor put the franchisee in the same position as it would have been in had the contract been properly fulfilled. In particular, the franchisor shall in such a case owe compensation for loss of profit. However, it is not possible for the franchisee to insist on the continuation of the contractual relationship, so the remedy available to franchisees is limited to damages only.
Ongoing franchisor/franchisee relationship
What mechanisms (formal and informal) are commonly used by franchisors to ensure franchisee compliance with the operational terms and standards of the agreement?
Most franchise agreements provide for the franchisor's right to monitor the franchisee’s compliance with quality standards in day-to-day operations – for instance, through unannounced inspections during normal business hours. Franchisors usually make use of the services of area managers who will visit franchisees in the territory that they serve and carry out inspections using checklists. Depending on the type of non-compliance involved, the franchisor has various instruments at its disposal. If contractual penalties are provided for in the franchise agreement in the case of certain infringements, these can be imposed if a prior warning was fruitless. Failure by a franchisee to send the turnover figures relevant for the payment of franchise fees may result in the franchisor making estimates if so provided for in the franchise agreement. In certain cases – for instance, infringement of trademark rights or endangering third parties by non-compliance with quality standards – termination is the only way to prevent significant damage from occurring.
Amendment of operational terms
Can the franchisor unilaterally change operational terms and standards during the course of the agreement?
German law allows the franchisor to make certain system-relevant changes to the franchise agreement and to demand their implementation by the franchisee, provided that:
- the request for modifications is communicated with sufficient notice; and
- the changes do not unreasonably affect the franchisee.
In the event of changes that require investments on the part of the franchisee, or changes that have a material and significant effect on operational processes, the courts will examine in case of litigation on a case-by-case basis whether an adjustment would unduly violate the franchisee's legitimate interests.
Do any specific laws affect the ongoing franchisor/franchisee relationship after they enter into the franchise agreement?
During the term of the agreement, each contracting party must comply with any legal provisions that are associated with the exercise of the rights and obligations arising from the franchise agreement. No special franchise laws or regulations apply.
Do any ongoing disclosure requirements apply during the course of the agreement?
Where amendments are made to the legal framework of a franchise system, the franchisor would be well advised to inform its franchisees of such change, as it is assumed that the franchisor itself has a higher duty of care in this respect. If the survival of the system is threatened (eg, by the failure of a large number of franchisees), a franchisor's obligation to inform the franchisees may also result from this principle. In addition, the principle of good-faith performance as laid down in Section 242 of the Civil Code is to be taken into account at all times in the ongoing contractual relationships.
Transfer and sale
Transfer and sale
What rules and procedures apply to the transfer and sale of a franchise business?
The sale of a franchise business is governed the provisions of the franchise agreement. The parties are free to determine the conditions and the procedure applicable to the transfer of the business – for instance, with regard to a potential right of first refusal of the franchisor and the prerequisites for an approval of the franchisor to continue the franchise relationship with the purchaser of the business, or to grant a franchise to the third party purchasing the respective business.
What competition laws apply to franchises, with particular regard to:
(a) Non-competes and other restrictive covenants?
Restrictions on competition during the term of the franchise agreement are permissible and, ultimately, the result of a general duty of loyalty, as assumed in analogy to commercial agency law. Post-contractual restrictions on competition are permissible within certain limits only and must comply with commercial agency law provisions and EU law (Article 5(2) of the Block Exemption Regulation (330/2010)). The post-contractual non-compete obligation may be limited only to the sale of products competing with the contractual products or with the specific services of the system, may not exceed one year after termination and must be limited to the premises where the franchise business was operated. In addition, the franchisor owes the franchisee an appropriate amount of compensation for the duration of the post-contractual non-competition obligation in analogy to Section 90 of the German Commercial Code. Compliance with such a non-compete clause may be waived by the franchisor until six months prior to the expiry of the franchise agreement in order to avoid compensation payments.
(b) Exclusive geographical areas?
It is in principle possible to grant franchisees exclusivity insofar as the franchisor refrains from opening its own establishment in the area in question or from granting a franchise to a third party in that area. This exclusivity can be lawfully secured within a franchise system by prohibiting the franchisee from actively offering his or her products and services outside his or her designated territory. By contrast, a franchisor may not prohibit a franchisee from answering unsolicited customer inquiries from the (exclusive) territory of another franchisee or even oblige him or her to pass such customer inquiries on to the franchisee located in the same area as the customer. The right of passive distribution may not be restricted or excluded, as this would constitute a violation of Section 1 of the German Unfair Competition Act and Article 101 of the Treaty on the Functioning of the European Union (TFEU), for which no exemption may be granted under the of the Block Exemption Regulation.
(c) Price fixing and mandatory product purchases?
Price fixing constitutes a violation of Article 1 of the Unfair Competition Act and Article 101 of the TFEU, which may not be exempted under the provisions of the Block Exemption Regulation. Non-binding price recommendations and the setting of maximum prices are permissible if in accordance with Article 4a of the Block Exemption Regulation, provided that the market share of the franchisor and the franchisee is in each case less than 30%. Mandatory purchase commitments (including exclusive purchase obligations) are permissible if in line with the jurisprudence of the European Court of Justice (Pronuptia) and subject to the provisions of the Block Exemption Regulation, which allows exclusive purchase obligations up to a period of five years (Article 5a) or purchase commitments not exceeding 80 % of the franchisee's total purchases of the contract goods or services (Article 1d).
(d) Online trading?
A general prohibition of online distribution for franchisees is not permitted as this constitutes a hardcore restriction. Online distribution is regarded as a form of passive distribution, the limitation or exclusion of which is not permitted and cannot be exempted by the Block Exemption Regulation. However, a franchisor may prohibit franchisees from marketing the system-specific products via third-party online platforms such as Amazon or eBay, based on factual and product-related considerations.
How can franchisors protect their intellectual property (eg, trademarks and copyright)?
Ample opportunities for franchisors exist to protect their intellectual property. Most importantly, the application for registration of trademarks should be addressed and taken care of at the earliest point of time possible after a strategic decision of entering into the German market has been made.
Additional legal options for protection, such as protection of designs, copyrights and/or know-how, should be thoroughly examined and may in many cases assist to serve best the interests of the franchisor. Depending on the industry, the protection of store design may become an important issue, especially for situations in which franchisees decide to terminate agreements and thereby leave the franchise system.
Must IP licences be registered?
While German law does not require or offer the opportunity to register a trademark licence, a licence for an EU trademark can be registered with the EU Intellectual Property Office.
How can franchisors protect their know-how and trade secrets?
The protection of know-how and/or trade secrets is subject to statutory law provisions such as the Unfair Competition Act. For example, Sections 17 and 18 of the act stipulate that the unlawful use of material at issue is treated as a criminal offence subject to fines or imprisonment. In addition, civil law remedies are available – for instance, in conjunction with statutory law provisions of the German Civil Code under certain requirements.
Regardless of any statutory law provisions, it is essential that the obligations of the franchisee be set out clearly in the franchising agreement and in any other contracts between franchisor and franchisee in order for the franchisor to be able to sue a potential infringer.
What are the consequences of a franchisee’s breach of the franchisor’s IP, know-how or trade secret rights and what remedies are available to the franchisor in this regard?
In addition to the various statutory law provisions that allow a franchisor to commence legal action against a potential infringer of its intellectual property or the unlawful use or disclosure of know-how or trade secrets, contracts should be drafted carefully and thoroughly with respect to such rights in order to define the intellectual property of the franchisor. These contractual provisions would put a franchisor in a better position to take quick and effective legal action.
Where the relevant requirements are met, a franchisor will, as a first step, typically send out a cease and desist letter requesting that the franchisee:
- cease the infringement of the franchisor’s intellectual property;
- provide a signed cease and desist declaration;
- give detailed information in respect of the unlawful use;
- accept to pay damages.
In addition, the franchisor’s counsel will typically request for the reimbursement of attorneys’ fees.
Should the franchisee not meet the requests, the franchisor may then file an application for a preliminary injunction. While a cease and desist letter is not a prerequisite to filing court proceedings, taking that preliminary step may prevent the franchisor from having to reimburse certain costs in case the infringer accepts the cease and desist. Under German law, an application for a preliminary injunction may contain only claims that will not anticipate a later court decision – that is, it may not – for example – contain a claim for payment of any amount that the court may later reject in the main proceedings. In addition, the application must be filed within certain deadlines. Alternatively, though, the franchisor may commence legal action through main proceedings from the outset. Similarly, this is possible if the infringer does not finally accept a granted preliminary injunction as final and binding.
Laws and considerations
What real estate laws and considerations should franchisors bear in mind where:
(a) The franchisor owns the premises on which the franchisee operates?
The franchise relationship is not subject to any special real estate regulations. The franchisor, as the owner of a real estate property, which it rents out to a franchisee, is subject to the general regulations of building and real estate law applicable on a federal and local level.
(b) The franchisor sub-leases the premises to the franchisee?
The franchisor must ensure that the franchisee fulfils all obligations of the principal tenant (franchisor) under the main lease agreement. It is not sufficient merely to refer to the main lease agreement in the sub-lease agreement. Instead, the provisions of the main lease agreement must be incorporated into the sub-lease agreement with the franchisee. The parties may agree that the franchisee pay the lease directly to the landlord. Nevertheless, the franchisor will remain liable for the payment of the lease under the main lease contract towards the landlord.
(c) The franchisee leases the premises from a third-party landlord?
In the event that the franchisor wishes to obtain a right of entry into the lease agreement between the franchisee and the landlord upon termination, this must be expressly stipulated in a tripartite agreement in which the landlord is involved. A provision to that effect in the franchise agreement is not sufficient. The detailed preconditions for the existence of such an entry right and the procedure to be followed must also be laid down in this tripartite agreement.
(d) The franchisee owns the premises?
The franchisee's consent to the franchisor's use of the object after termination of the franchise relationship is at the franchisee's sole discretion. The parties may conclude an agreement to this effect.
Can franchisees or their employees be regarded as employees of the franchisor for liability purposes? If so, how can franchisors mitigate this risk?
In Germany, a franchisee will be regarded as an employee of the franchisor in very specific circumstances only. A position similar to that of an employee can be assumed where, for instance, a single franchisee runs his or her business almost alone (ie, without any full-time employees) and has almost no entrepreneurial freedom because he or she is bound by instructions relating to working time, place of work and responsibility over any personnel. In order to avoid such dependence from the outset, it is advisable for a franchisor to interfere as little as possible in the actual management of the franchise operation and, in particular, not to require that the franchisee fulfil the contractual obligations personally. Influence on personnel sovereignty (eg, by selecting the franchisee's employees) should also be avoided. The franchisor's responsibility as an employer of the franchisee's employees would be possible only if the franchisor were to issue instructions to the employees and if the franchisor's behaviour were such that it would not be evident to the employees as a result of the franchisor's conduct that it is not the franchisor, but rather the franchisee, who is their employer.
Tax and currency controls
What tax regimes apply to the franchisor/franchisee relationship?
The key taxes in Germany are outlined below.
Income tax Natural persons are subject to income tax, which is determined in accordance with the Income Tax Act. If the income is generated from self-employed activities, such as a franchisee who concludes a franchise agreement as a natural person and runs the franchise business as an individual entrepreneur, this tax is established in the assessment procedure on the basis of the tax declaration filed by the franchisee.
Corporation tax If a franchisee is organised as a legal entity (eg, a limited liability company or GmbH), it is subject to corporation tax. In this instance, corporate income tax is the equivalent of income tax for individuals. It is a standard 15% plus a solidarity surcharge of 5.5%, which is payable in all cases – as with income tax. A franchisor resident in Germany established as a legal entity is subject to the same tax.
Sales tax Every business, whether run by a natural or legal person, must pay value added tax (VAT). VAT is imposed on self-employed persons whose activities are aimed at generating sustaining income. The general VAT rate is 19%. A reduced VAT rate of 7% applies to the sale of food, magazines and books, as well as artworks, among other things. Numerous particularities and exceptions apply. For example, 19% VAT is charged on food consumed on site in a restaurant, whereas only 7% is charged for food that the customer takes away.
Trade tax Municipalities tax the trade income from the local business operations. The rate varies between 7% and 17.5%, depending on the location of the establishment.
Services that the franchisor renders to the franchisee in accordance with the provisions of the franchise agreement are subject to VAT as ‘other services’ payable by the franchisor.
The payment of ongoing franchise fees and one-off compensation payments charged to the franchisee (eg, after the franchisee's (early) termination of the franchise agreement) and received by the franchisor are subject to corporation tax. The franchisee can deduct these costs as operating expenses.
If the franchisee receives a profit from the sale of his or her business to the franchisor or to a third party, this profit can be tax-privileged as extraordinary income.
The franchisee may claim the entry fee immediately as a deductible business expense if it is related to the franchisor's direct services (eg, training, advertising) after entering into the franchise agreement.
If the entry fee (also) is charged as consideration for granting exclusivity for a certain territory, this is considered as an acquisition of an intangible asset for tax purposes. The entry fee must then be activated and written off over the lifetime of the agreement.
The franchisor may declare the entry fee collected from the franchisee as an operating income in the year of its creation. It is subject to VAT at the standard tax rate of 19%.
If the franchisor is based in the European Union and delivers goods to the franchisee located in Germany for his or her franchise business, then this is considered a tax-exempt intra-EU transfer. Sales tax is charged at the level of the purchasing entrepreneur (ie, the franchisee).
A franchisor resident in the European Union must provide proof to the tax authority in its country of residence that the goods have been delivered to another EU member state, and that their purchase is taxed there. This is the only way to safeguard tax exemption. In addition, the franchisee must have a valid VAT ID number as the purchaser of these goods in order for the transaction to qualify for tax exemption.
The franchisee (buyer) in Germany must declare the purchase from the franchisor resident in another EU member state within the course of his or her current VAT declaration and pay the applicable VAT to the local tax authority. He or she can deduct this sales tax as input tax from his or her total sales tax liability.
For contractual relationships with franchisors domiciled in a country outside the European Union, the provisions of the relevant double taxation agreements apply.
Do any currency controls apply with respect to foreign franchisors?
No specific currency controls apply.
What issues are typically the subject of disputes arising in the franchisor/franchisee relationship?
Disputes in ongoing franchise relationships arise mostly due to the default or late payment of franchise fees. Violation of the franchisor's guidelines with regard to adherence to certain quality standards or optical requirements also gives rise to conflicts. In addition, there is often disagreement as to what action the franchisor must take to develop and enhance the system, and to maintain its competitiveness. As a result of the decline of retail business and the simultaneous rise of e-commerce, disputes concerning territorial protection and competition, as well as regarding the support that the franchisor must provide in any digitalisation process, are increasingly frequent.
Which venues are empowered to hear franchising disputes in your jurisdiction? What considerations should be borne in mind when choosing a venue?
Disputes between franchisors and franchisees can be brought before any competent court in Germany. No court has a higher degree of specialisation or experience in franchise-related matters and no court has a reputation for judicial bias towards franchisors. Thus, it makes sense for the franchisor to choose a venue in the vicinity of its offices in order to minimise the time and effort involved in travel.
Alternative dispute resolution
Is alternative dispute resolution (ADR) commonly used for franchising disputes in your jurisdiction? What considerations should be borne in mind when opting for ADR?
The use of mediation in relation to franchise disputes has so far been limited in Germany. Although the German Franchise Association offers support in mediation proceedings and more and more specialists recommend using mediation proceedings instead of litigation, most franchise agreements still provide for dispute resolution through ordinary courts or arbitration bodies. That said, some franchising agreements provide that mediation is a prerequisite to filing a lawsuit with the ordinary courts, and since court proceedings are more time consuming and expensive than mediation, and since the relationship between franchisors and franchisees is based on the concept of partnership, mediation is likely to become an attractive alternative to litigation.
Foreign judgments and awards
What regulations and procedures apply to the recognition of foreign judgments and arbitral awards where international franchising networks are concerned?
In principle, Germany recognises the final judgment of a foreign court. However, a foreign judgment is not directly enforceable as such; it must first be declared enforceable by a competent German court. The procedure to be followed varies depending on where the judgement was obtained, whether in an EU member state or a third country.
With the exception of judgments obtained in another EU member state, a franchisor must bring enforcement proceedings before the German court whose competence is governed by German civil procedural law. According to Section 328 of the Code of Civil Procedure, a foreign court judgment is not eligible for recognition only on the following conditions:
- The foreign court did not have jurisdiction according to German law;
- The defendant, who has not entered an appearance in the proceedings and who takes recourse to this fact, has not duly been served the document by which the proceedings were initiated, or not in such time to allow him or her to defend him/herself;
- The judgment is incompatible with a judgment delivered in Germany, or with an earlier judgment handed down abroad that is to be recognised, or if the proceedings on which such judgment is based are incompatible with proceedings that have become pending earlier in Germany;
- The recognition of the judgment would lead to a result that is obviously incompatible with essential principles of German law and, in particular, if the recognition is not compatible with fundamental rights; and
- Reciprocity has not been granted.
If the foreign judgment is a court ruling of a competent court in another EU member state, the exequatur procedure does not apply. Instead, at the motion of one party (eg, the franchisor that has obtained the judgment), the competent court in Germany will issue an enforcement clause to the foreign judgment. With this, the franchisor can then directly proceed with the enforcement in Germany. The provisions of the Recast Brussels Regulation (1215/2012) on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters are given priority to the exequatur procedure described above.
In the case of international arbitral awards, Section 1061 of the German Code of Civil Procedure applies, according to which the recognition and enforceability of foreign arbitral awards is governed by the New York Convention of June 10 1958.
Here, too, the enforceability of the award must first be declared by the competent German court upon a motion by the franchisor.
It should be noted, though, that a German court may, at the request of the other party, annul a foreign arbitral award on the grounds that general procedural rules have not been observed in the arbitration proceedings, and that this has had an effect on the award. This includes, for example, a violation of the principle to grant legal hearing. Similarly, a German court may refuse to recognise a foreign arbitral award if the recognition or enforcement would constitute a violation of the principle of the public order.
For example, a franchisor was refused recognition of arbitration awards obtained in New York against franchisees in Germany on the grounds of violation of the franchisees’ hearing rights. The franchise agreement stipulated New York as the place of arbitration, although the business seat of the franchisor was in the Netherlands and the franchise businesses were operated by German franchisees in Germany. The court considered that the franchisees were disproportionally disadvantaged by the place of arbitration in this situation.