This chapter is taken from Lexology GTDT’s Practice Guide to Franchise, examining key themes topical to cross border franchising.
Introduction: the increasing importance of electronic commerce
Some general trends and figures
We are truly a digital society and the European Union is one of the largest electronic commerce (e-commerce) markets in the world today. Businesses increasingly interact online with customers and business partners. Browsing, chatting and online shopping are everyday activities that use information and communication technologies.2 The internet is the cornerstone for e-commerce web sales (via a website or app).3
In 2017, 16 per cent of EU businesses reported generating web sales online (via a website or app). Ireland reported the highest number of businesses with web sales (25 per cent), followed by Denmark and Germany (both 23 per cent), and Sweden (22 per cent).4 The share of total EU turnover generated from such web sales amounted to 5 per cent. Ireland also had the highest share of total turnover generated from web sales (15 per cent) followed by Belgium (11 per cent), and Sweden and the United Kingdom (both 8 per cent).
Belgium registered the highest share of business-to-business (B2B) web sales (10 per cent), followed by the Czech Republic and Denmark (both 5 per cent).5 The share of turnover generated from business-to-consumer (B2C) sales was highest in Ireland (12 per cent), followed by the United Kingdom (4 per cent), and Belgium, Spain, Holland and Sweden (all 3 per cent).6
The e-commerce sector enquiry
The EU Commission’s recent e-commerce sector enquiry found that, while price is a key parameter of competition between retailers, quality, brand image and innovation are important in the competition between brands:
Incentivising innovation and quality and keeping control over the image and positioning of their brand are of major importance for most manufacturers to help them ensure the viability of their business in the mid to long-term.7
The e-commerce enquiry noted both the ability of retailers to leverage online distribution models in order to access customers, thereby increasing the size of their potential customer base, and the potential for such initiatives to clash with the distribution and brand strategies of manufacturers.8
Even if certain characteristics of the franchise relationship – and notably the know-how that is transferred from franchisor to franchisee – distinguish it from re-selling or distribution, replacing the word ‘manufacturers’ by ‘franchisors’ in the previous two paragraphs makes the challenges that franchisors, franchisees and franchise networks must meet in order to prosper in the new e-commerce environment clear. Those challenges are discussed below.
The changing online legislative context for electronic commerce
The geo-blocking regulation
On 3 December 2018, new rules against ‘geo-blocking’ entered into force in the EU.9The new rules are part of a wider package of measures under the EU’s Digital Single Market Strategy,10 aimed at boosting cross-border e-commerce in the EU.
Geo-blocking refers to online sellers’ practices that restrict online cross-border sales based on nationality, residence or place of establishment. Such geo-blocking practices include denying access to websites from other member states, or situations where access to a website is granted, but the customer from abroad is prevented from finalising the purchase or is asked to pay with a debit or credit card from a certain country.11
Access to websites
Article 3 of the Regulation bans the blocking of access to websites and rerouting without the customer’s prior consent. This increases price transparency by allowing customers to access different national websites. This provision also applies to non-audiovisual services supplied electronically, such as e-books, music, games and software.
For example, say an Irish customer wants to access the Italian version of an online clothing store’s website. Even though she types in the URL of the Italian site, she still gets redirected to the Irish site. After 3 December 2018, being redirected will require the customer’s explicit consent. Moreover, even if the customer gives consent to the redirection, the original version she sought to visit should remain accessible.12
Cross-border parcel deliveries
A new Regulation makes prices for cross-border parcel delivery services more transparent. It is also intended to make such services more affordable and to increase regulatory oversight of the EU parcel market.13 It became applicable as of 22 May 2018.14 By making it easier for consumers and smaller companies to buy and sell products and services online with confidence across the EU, it is expected to boost e-commerce within the EU.
Simplification of VAT rules for cross-border sales of telecommunications, broadcasting and electronically supplied services by SMEs
The value added tax (VAT) e-commerce package adopted by the European Council on 5 December 2017 includes several changes to the place of supply rules.15 The purpose of these changes is to reduce the burden for small and medium-sized enterprises (SMEs) established in a member state supplying telecommunications, broadcasting and electronically supplied (TBE) services to customers in other member states. From 1 January 2021, these rules will simplify VAT collection when consumers buy goods and services online from another member state or a non-EU country by introducing the possibility for the suppliers to use the VAT Mini One Stop Shop.16
Changes that apply to the supply of intra-EU TBE services from 2019
An annual €10,000 turnover threshold was introduced on 1 January 2019, up to which the place of supply of relevant supplies of cross-border TBE services remains in the member state where the supplier is established, has his or her permanent address or usually resides. (The application of this threshold is subject to conditions.)
For supplies above €10,000, a further threshold of €100,000 was introduced on 1 January 2019, up to which a single piece of evidence is sufficient to determine the place of supply of TBE services (as opposed to the two required previously).17 (The application of this threshold is also subject to conditions.18
Proposed digital contract rules
The proposed digital contract rules include two draft pieces of legislation:
- a proposal for a directive on contracts for supply of digital content;19
- a proposal for a directive containing contractual rules for online sale of tangible goods.20
The two proposals have common objectives, notably to remove obstacles to cross-border e-commerce in the EU, notably legal fragmentation in the areas of consumer contract law that results in high costs for businesses and low consumer trust when buying online in another country.
Using the e-commerce channel: how and when challenges may arise
Challenges for franchisors and franchisees
Where issues around e-commerce have not been adequately dealt with previously, they will tend to arise either on a franchise renewal or when the franchisor tries to introduce new standard terms.
The point is helpfully illustrated by a franchise dispute that occurred in New South Wales, Australia in 2000. Dymocks, the largest bookseller in Australia, established its franchise system in 1986. The franchise agreements at issue in Dymocks Holdings v Top Ryde Booksellers21 provided an option for renewal on the terms of the Dymocks’ standard form of agreement. However, when the franchisor subsequently introduced a new form of agreement it precluded any claim by the franchisees to commercial participation in the franchisor’s website.
The new standard form agreement that was introduced contained a definition of Dymocks’ website and various acknowledgments and restrictions on the franchisee, including that:
- the franchisee must have no legal or equitable interest of any nature or description whatever in any Dymocks website or any business conducted through or any revenue derived from the operation of such website;
- the existence and operation of such website for home shopping must provide a benefit to the franchisees because it increases brand awareness by members of the public of the Dymocks name and brand; and
- the franchisee must not hold a direct or indirect interest in a website incorporating or including the word Dymocks without prior written consent from a member of the Dymocks Group.
After a challenge by the franchisee, the New South Wales Supreme Court held that Dymocks was not entitled to defeat its original unqualified promise that its website would be the property of the advertising fund (and therefore an asset shared with the franchisees) through its new standard form agreement. The franchisees were therefore entitled to compensation on the basis that the website remained an asset of the advertising fund.
Tyre 20 v Fleet Mobile Tyres
A similar dispute arose in the Tyre 20 v Fleet Mobile Tyres case heard by the Court of Appeal in England in August 2006.22 The case concerned a mobile tyre-fitting service in which the mobile fitter would travel to the vehicle in question and fit a new tyre by the roadside, in the driveway or wherever was convenient for the customer, instead of taking the vehicle to a garage. Much of the new business was achieved by local efforts of the franchisee in its particular territory, but some came from National Account Customers managed by the franchisor. From about 1997 the defendant franchisor developed an ‘eTyres’ website managed by head office staff.
The dispute that arose between the parties concerned the eTyres work, which was originally a minority element of the total balance of work. Although the eTyres work was part of the business franchised to the appellant under the franchise agreement, the defendant franchisor only passed on the eTyres work after making deductions so that the work was less profitable for the appellant franchisees.23
In October 2004, all franchisees, including the appellants, were told that the franchisor was going to take initiatives to promote its eTyres brand. The initiatives included changing signage on the vans to identify eTyres as the principal brand with similar changes to business cards, stationery and promotions on which eTyres was to be the only branding. The appellants claimed that in result they were entitled to treat the franchise agreement as having been wrongfully terminated by the franchisor.
The Court held that it was clear that the franchisor’s instructions would have prevented the appellants from effectively promoting the ‘Fleet Mobile Tyres’ aspect of the franchise. The eTyres part of the business would have predominated but that was a part of the business where the prices to the customer were assessed by the franchisor not by the franchisee. Whereas the franchise agreement clearly contemplated that the Fleet Mobile Tyres work was to be a significant part of the franchise business, the franchisor was effectively imposing far-reaching restrictions on the franchisee’s ability to promote the part of the business where it set the sale price directly with the customer. Accordingly, the appellants were entitled to treat the franchise agreement as having been terminated by the franchisor.
Scope for improving the performance of franchising in Europe
A September 2016 paper considered how the regulatory environment of the EU impacts on franchising.24 The core thesis of the paper was that franchising is substantially underperforming in the EU. The evidence cited for that proposition was that 83.5 per cent of franchising turnover in the EU was concentrated in only 25 per cent of the member states and constituted only 1.86 per cent of the EU’s GDP.25(This compared unfavourably with 5.95 per cent of GDP in the US and 10.83 per cent of GDP in Australia.)
Among the criticisms levied at the position of franchising within the EU was a lack of recognition and support for multichannel sales, online sales and other commercial use of the internet.26 In particular, the EU Commission was criticised in the paper for failing to understand the dynamic and interactive nature of the worldwide web, thus using an outmoded approach to the latest developments in electronic commerce: ‘[b]y seeing the Internet as a passive medium comparable to a journal or newspaper the importance of multi-channel sales strategies is totally missed’.27
EU franchisors: controls over internet use
The EU Vertical Agreements Block Exemption Regulation
The EU’s general competition rules, set out in article 101(1) of the Treaty on the Functioning of the European Union (TFEU), prohibit restrictive agreements made between undertakings that may affect trade between member states and whose object or effect is the prevention, restriction or distortion of competition within the EU internal market. Based on previous experience, the EU Vertical Agreements Block Exemption Regulation (VBER) exempts certain contractual arrangements found in business agreements and practices from the prohibition set out in article 101(1) TFEU. It also clarifies that certain other (‘hard-core’) clauses restricting competition do not benefit from that exemption.28
The Commission Guidelines on Vertical Restraints
The distinction that EU competition law makes between active and passive selling outside an allocated contract territory is well known. The Commission’s Guidelines on Vertical Restraints (CGVR), which support the VBER, define ‘passive sales’ in paragraph 51 as:
responding to unsolicited requests from individual customers including delivery of goods or services to such customers. General advertising or promotion that reaches customers in other distributors’ (exclusive) territories or customer groups but which is a reasonable way to reach customers outside those territories or customer groups, for instance to reach customers in one’s own territory, are considered passive selling. General advertising or promotion is considered a reasonable way to reach such customers if it would be attractive for the buyer to undertake these investments also if they would not reach customers in other distributors’ (exclusive) territories or customer groups.
The CGVR set out a number of ways in which restrictions on internet sales may restrict competition, and paragraph 52 states:
The internet is a powerful tool to reach a greater number and variety of customers than by more traditional sales methods, which explains why certain restrictions on the use of the internet are dealt with as (re)sales restrictions. In principle, every distributor must be allowed to use the internet to sell products. . . . The Commission thus regards the following as examples of hardcore restrictions of passive selling given the capability of these restrictions to limit the distributor’s access to a greater number and variety of customers: . . . (c) an agreement that the distributor shall limit its proportion of overall sales made over the internet.29
However, paragraph 54 of the CGVR qualifies the general position stated above to the extent that it recognises that quality standards may also be relevant to sales over the internet, in particular in the context of selective distribution agreements:
[under the VBER] the supplier may require quality standards for the use of the internet site to resell its goods, just as the supplier may require quality standards for a shop or for selling by catalogue or for advertising and promotion in general. This may be relevant in particular for selective distribution. Under the [VBER], the supplier may, for example, require that its distributors have one or more brick and mortar shops or showrooms as a condition for becoming a member of its distribution system . . . Similarly, a supplier may require that its distributors use third-party platforms to distribute the contract products only in accordance with the standards and conditions agreed between the supplier and its distributors for the distributors’ use of the internet. For instance, where the distributor’s website is hosted by a third-party platform, the supplier may require that customers do not visit the distributor’s website through a site carrying the name or logo of the third-party platform.
The CJEU’s jurisprudence
Although the Commission’s guidance in the CGVR is persuasive,30 it is ‘soft law’ and must be read subject to judicial interpretation of the relevant law by the Court of Justice of the European Union (CJEU) and the General Court.31 Two significant judgments, Pierre Fabre and Coty, have helped throw some light on what contract terms a franchisor may (and may not) adopt to regulate its franchisees’ use of internet marketing. Both cases concerned selective distribution systems.
Pierre Fabre Dermo-Cosmétique (PFDC) established a selective distribution system for certain cosmetic and personal care products under specified brands. The distribution contracts for those products stipulated that sales must be made exclusively in a physical space, in which a qualified pharmacist must be present to give advice to the customer on the product best suited to specific health or care matters.
Article 1.1 of the general conditions of those contracts required each distributor:
to supply evidence that there will be physically present at its outlet at all times during the hours it is open at least one person specially trained . . . to give on-the-spot advice concerning sale of the [PFDC] product that is best suited to the specific health or care matters raised with him or her, in particular those concerning the skin, hair and nails. In order to do this the person in question must have a degree in pharmacy awarded or recognised in France.
Article 1.2 stated that the products concerned might only be sold ‘at a marked, specially allocated outlet’. It was accepted that the distribution contracts de facto excluded sale of the PFDC products via the internet.
In its Judgment,32 on a preliminary reference from the Paris Court of Appeal the CJEU held that article 101(1) TFEU must be interpreted as meaning that (in the context of a selective distribution system) a contractual clause resulting in a ban on the use of the internet for sales amounts to a by object restriction on competition where:
following an individual and specific examination of the content and objective of that contractual clause and the legal and economic context of which it forms a part, it is apparent that, having regard to the properties of the products at issue, that clause is not objectively justified.33
A more recent case, Coty,34 concerned a manufacturer of luxury cosmetics that banned its selected distributors from using third-party online market places such as Amazon. Unlike the total sales ban in Pierre Fabre, the internet sales restriction in Coty was not absolute since authorised distributors were permitted to sell online via their own websites.
Apart from requirements that a bricks-and-mortar sales location must highlight and promote the luxury character of Coty brands,35 the contractual framework linking the parties included a supplemental agreement on internet sales, which provided, in Clause 1(3), that ‘the authorised retailer is not permitted to use a different name or to engage a third-party undertaking which has not been authorised.’
In March 2012, Coty Germany revised both the selective distribution network contracts and the supplemental agreement on internet sales. It provided in Clause I(1) of the supplemental agreement that:
the authorised retailer is entitled to offer and sell the products on the internet, provided, however, that [such] internet sales activity is conducted through an ‘electronic shop window’ of the authorised store and the luxury character of the products is preserved.
Further, Clause I(1)(3) of that supplemental agreement expressly prohibited the use of a different business name or the recognisable engagement of a third-party undertaking that was not an authorised retailer of Coty Prestige. A footnote to that clause stated that:
accordingly, the authorised retailer is prohibited from collaborating with third parties if such collaboration is directed at the operation of the website and is effected in a manner that is discernible to the public.
Coty’s long-time distributor, Parfümerie Akzente, refused to approve the proposed amendments to the distribution contract, and Coty Germany brought an action before a national court of first instance seeking an order prohibiting the distribution of products bearing the brand at issue via the platform ‘amazon.de’, in application of Clause I(1)(3).
In its Judgment, on a preliminary reference from the Oberlandesgericht Frankfurt am Main, the CJEU addressed the lawfulness of the specific clause prohibiting the use of third-party online market places. It first clarified that a specific contractual clause designed to preserve the luxury image of goods will be lawful under article 101(1) TFEU provided it is proportionate to the objective pursued.36, 37
The Court of Justice went on to analyse whether the restriction on third-party online market places was proportionate. It indicated in paragraphs 55–57 that such restrictions were likely to be proportionate to the aim of preserving the luxury image of the products in question.
With regard to the latter point, it is particularly helpful to also take account of Advocate General Wahl’s opinion in Coty.38 Advocate General Wahl had also concluded that the prohibition on online market places was likely to be proportionate and contrasted that situation with the contract arrangements in Pierre Fabre.
In his view the prohibition on authorised distributors making use of third-party online platforms may be excluded from the scope of article 101(1) TFEU:
in that it is likely to improve competition based on qualitative criteria. By expanding on the considerations hitherto applied in relation to selective distribution, that prohibition is likely to improve the luxury image of the products concerned in various respects: not only does it ensure that those products are sold in an environment that meets the qualitative requirements imposed by the head of the distribution network, but it also makes it possible to guard against the phenomena of parasitism, by ensuring that the investments and efforts made by the supplier and by other authorised distributors to improve the quality and image of the products concerned do not benefit other undertakings.
That prohibition is clearly distinguished from the clause at issue in [Pierre Fabre].39
After contrasting that situation with the absolute ban on internet sales resulting from the contract terms in Pierre Fabre,40 he continued:
The clause at issue in the main proceedings still allows authorised distributors to distribute the contract products via their own internet sites. Likewise, it does not prohibit those distributors from making use of third-party platforms in a non-discernible manner in order to distribute those products.
As the Commission has observed, relying in particular on the results of its sector inquiry, it is apparent that, at this stage of the development of e-commerce, distributors’ own online stores are the preferred distribution channel for distribution via the internet. Thus, notwithstanding the increasing significance of third-party platforms in the marketing of retailers’ products, the fact that authorised distributors are prohibited from making use in a discernible manner of those platforms cannot, in the present state of development of e-commerce, be assimilated to an outright ban on or a substantial restriction of internet sales.41
Ping Europe Ltd: A National Decision invoking the EU jurisprudence
In August 2017, the United Kingdom’s Competition and Markets Authority (CMA) issued a decision fining Ping Europe Ltd for a ban on its approved retailers selling its products over the internet. In the Decision, the CMA found that Ping, a manufacturer of golf clubs, golf accessories and clothing, had infringed the prohibition in Chapter I of the UK Competition Act 1998 and article 101 of the TFEU against restrictive agreements by entering into agreements with two UK retailers containing clauses prohibiting those retailers from selling Ping golf clubs online.
The Decision found that those agreements restricted competition by object and did not benefit from any exclusion or exemption. It directed Ping to bring the alleged infringements to an end and imposed a fine of £1.45 million. Ping filed a notice of appeal on 25 October 2017 contesting both the finding of infringement and the imposition and amount of the penalty. In summary, the UK Competition Appeals Tribunal upheld the CMA’s finding that Ping’s contract terms were an infringement of the Chapter I Prohibition of the UK Competition Act and article 101 TFEU by object.42
Social commerce, a subset of e-commerce, can be defined as the delivery of e-commerce activities and transactions via the social media environment (mostly on social networks and by using participative software). Joining a blog or discussion group on a brand-related topic in which likes, dislikes, opinions and activities are shared, would be included in social commerce. However, notwithstanding the popularity of social media itself, and with the exception of the endorsement activities of certain online personalities, few social commerce vendors have so far achieved prominence.
Factors that affect social commerce
A recent article for the Journal of Retailing and Consumer Services investigated various factors that influence social commerce on Instagram.43 Their results confirmed (among other things) the positive effects on social commerce of trust, user habits and perceived ease of use. In business terms, their conclusions indicated that social commerce vendors should understand and be attentive to the specificity of the social commerce platform in question:
Instagram is built on the principle of sharing pictures and videos with friends or, as the company would call it on its official website, . . . ‘we’re building Instagram to allow you to experience moments in your friends’ lives through pictures as they happen’ (Instagram Team, 2015). Compared to other social media platforms, Instagram is mainly focused on the ease and simplicity of sharing visual media from smartphones. Firms are not expected to interact with users on Instagram. However, they may share images and videos about their offerings, which fits to the platform usage; and they may foster social interactions between users.44
Although the research focused on Instagram, the business conclusions would seem broadly applicable to other social media sites such as Facebook, MySpace, Twitter or LinkedIn.
Potential drawbacks of social commerce – a note of caution
The recent article ‘Social media revenge: A typology of online consumer revenge’ provides an analysis of the potential drawbacks of social commerce.45 The managerial implications include that companies can generally prevent revenge actions (by which angry customers strike back at firms that they feel have wronged them) on social media by offering quick and suitable recovery actions as soon as a customer makes a complaint.46
Conclusions and practical suggestions for franchise networks
Challenges for franchisors and franchisees
The challenges raised above essentially concern three different problems, namely: (i) encroachment (both by the franchisor on its franchisees’ sales and by franchisees outside their allocated territories);47 (ii) free-riding (or what Advocate General Wahl referred to as ‘parasitism’ in his Coty opinion48); and (iii) the franchisor’s ability to exercise a measure of control over its franchisees’ websites.49
Problems tend to surface when agreements are renewed or general terms and conditions are changed. The implementation of e-commerce in the franchising network is a real challenge for the commercial relations between the franchisor and its franchisees. Factors that may affect the extent to which franchisees are willing to accept new contract terms for the e-commerce channel include the scale and the age of the franchise network (an objective factor) and the level of trust in the franchisor (a subjective factor).50
Multi-channel sales and the e-commerce environment
Clearly the political and legislative initiatives being taken now are intended to facilitate the development of cross-border e-commerce within the EU in the future. These are not necessarily developments that will affect all franchise networks, many of which will have an essentially local customer base, but they do provide both opportunities and threats for franchises based on products or services capable of being marketed and distributed across borders.
Application of the VBER, the CGVR and the CJEU case law
It is clear from the VBER and the explanations provided in the CGVR that the broad assumption of EU competition law (which is largely mirrored by individual member states’ competition laws, but without the requirement that there shall be an effect on trade between member states) is that franchisees shall be given access to the internet as a marketing channel. Nevertheless, the case law indicates that such access may be subjected to certain qualitative requirements.
The business format franchise certainly has characteristics that are very similar to selective distribution in respect of maintaining the quality and prestige of the business offering. As Advocate General Wahl explained in Coty: ‘at this stage of the development of e-commerce, distributors’ own online stores are the preferred distribution channel for distribution via the internet’. However, that does not in itself solve the issue of whether individual franchisees or the franchisor should operate the website.
Rather than adopt the Coty approach (of authorising the franchisee’s internet sales provided they are made through a recognisable franchise ‘shop window’), certain franchisors may decide to take on the responsibility for organising internet sales and marketing centrally.51 If they do so they will need to respect the contracts with and the autonomy of the franchisees, have regard to the balance between online and bricks-and-mortar sales, while also respecting the CGVR guidance.52 This may require substantial investment in state-of-the-art online platforms to stimulate franchisee usage. There will therefore need to be agreement on an acceptable sharing of both the costs (investments) and the benefits, which recognises the importance of maintaining commercial relations based on mutual trust and cooperation.53
Each franchisor must set up a system to address the issue of e-commerce and develop policies and procedures most effective for their specific franchise that will adequately address and take care of the needs and objectives of both parties.54
Evaluation of the VBER and public consultation
In the meantime, the VBER is set to expire on 31 May 2022 and the EU Commission has started a process of evaluation to check whether the Regulation is still ‘effective, efficient, relevant, in line with other EU legislation and adds value’. A public consultation lasting 12 weeks will be launched in the first quarter of 2019.55 To the extent that franchise networks and the European Franchise Associations feel the rules affecting franchises need to be changed or clarified, this will be an opportunity to put those views forward.