Legal restrictions on franchise contracts and the relationship between the parties

Franchise relationship laws

Are there specific laws regulating the ongoing relationship between franchisor and franchisee after the franchise contract comes into effect?

No, there are no specific laws regulating the ongoing relationship between franchisor and franchisee during the course of performance of the franchise agreement. The aspect of the relationship involved will determine what laws apply: contract law, consumer law, competition law, product liability, intellectual property law, employment law, personal data protection laws, etc.

Operational compliance

What mechanisms are commonly incorporated in agreements to ensure operational compliance and standards?

Likewise, franchise systems need to be able to monitor their franchisees for system compliance to ensure brand protection including operation of the franchisee business within the concept and satisfying their other obligations to the franchisor. This monitoring also enables to prove that the franchisor complies with its obligation of technical and commercial assistance. Consequently, most franchise agreements give the franchisor the right to audit franchisee compliance, reporting requirements, obligation of communication of accountant documents by the franchisee and occurrence of ‘mystery shopper’ visits held by the franchisor. However, this monitoring does not have to create interference of the franchisor in the management of the franchisee.

Therefore, such a clause has to be carefully drafted and operated in practice. Indeed, for example, the French courts generally authorise a franchisor to issue instructions with a direct impact on the working conditions of franchisees’ employees, provided that this is necessary to maintain the reputation and the uniformity of the franchise network. If the franchisor issues direct and nominative instructions to franchisees’ employees or gets involved in hiring or firing, and more generally interferes in the management of the franchisee beyond its technical and commercial assistance obligations arising from the franchising agreement, the franchisor might be held to be the de facto manager of the franchisee and be liable for serious wrongdoing should it cause, for example, the franchisee’s insolvency. Therefore, the franchisor may be ordered to cover the liabilities of the bankrupt franchisee or dismissal of employees of the franchisee

Amendment of operational terms

May the franchisor unilaterally change operational terms and standards during the franchise relationship?

Usually, the franchise agreement, as well as any contract, cannot be modified unilaterally by the franchisor or the franchisee. Therefore, the parties will have to conclude an addendum. Furthermore, prior information has to be organised between the franchisor and the franchisee regarding the different modifications to be made.

However, it is true that the franchisor has also an obligation to evolve the system. For franchisees, franchisors should be duty bound to develop and innovate the system and keep it competitive against other similar systems. So change could happen during the operation of the franchise agreement. Therefore, in order to avoid seeking franchisee’s consent on this evolution, we would recommend inserting an ‘evolution’ clause, strictly defining the scope where the agreement of the franchisee will not be required and the right to modify, for example, the operational manual from time to time. This clause would have to be clearly drafted especially if in practice this could lead to financial or important operation constraints for the franchisee.

Other laws affecting franchise relations

Do other laws affect the franchise relationship?

See question 27. In case of litigation between the franchisor and the franchisee, procedural law, employment law, or arbitration law could also apply. The French Data Protection Act, as recently amended in 2018, implementing the EU General Data Protection Regulation in particular, might also apply in the context of a franchise relationship as regulating the processing of personal data and containing restrictions on the transfer of such data to other countries.

Policy affecting franchise relations

Do other government or trade association policies affect the franchise relationship?

There is no government policy that significantly affects the franchise relationship. Regarding trade association policies, the European Code of Ethics for Franchising and AFNOR standard (NF Z-20 000), which are non-binding rules, provide guidelines to their members on good practices to be implemented in their franchise relationships. The European Code, for example, contains guiding principles and sets forth the respective rights and obligations of the franchisor and of the franchisee, specifically in terms of recruitment and membership, the operation of the network, and the contractual relationship before, during and after the termination of the franchise agreement.

Termination by franchisor

In what circumstances may a franchisor terminate a franchise relationship? What are the specific legal restrictions on a franchisor’s ability to terminate a franchise relationship?

A franchise agreement is typically entered into for fixed term, and can be successively renewed as per the terms of the agreement. If not renewed, the contractual notice period must be complied with, such notice being required to be ‘reasonable’ so as not to run afoul of the provisions of section L.442-6(I)5 of the Commercial Code, on sudden termination of an established business relationship.

Unless the agreement contains a specific clause permitting termination by the franchisor in certain circumstances pertaining, for example, to the revenue made with the franchisee, and unless the franchisee has committed contractual breaches, early termination by the franchisor is not possible. In practice, termination of the franchise relationship at the initiative of the licensor will occur if the franchisee fails to pay the franchise royalties, the goods delivered by the franchisor or commits material breaches of the franchise agreement, such as failure to respect the concept, disclosure of know-how, infringement of the franchisor’s intellectual property or failure to comply with exclusive sourcing requirements. Under no circumstances is the opening of insolvency or similar proceedings against a franchisee grounds for termination of the franchise agreement under the mandatory public policy rules applicable. The termination clause contained in the agreement authorises the franchisor to directly terminate the agreement without having to go through the courts. The formalities indicated in the agreement should be complied with: typically, a termination clause will require a notice of breach, a time frame (or not) in which to cure the notified breach and the effective date of termination. If the franchise agreement does not contain a termination clause, but is terminated by the franchisor, the matter will ultimately be decided by the courts in the event that the franchisee challenges the termination. New legislative provisions on the rescission of contracts that could have an impact on the franchise relationship (new sections 1224 through 1230 of the Civil Code) having introduced major changes. In summary:

  • the term résolution (rendered here as rescission, and previously used now as a generic term for ending an agreement) has replaced the term résiliation (rendered here as termination for the future), the use of which is now reserved to cases where a court cancels an agreement without ordering restitution of any services that have already been performed (new section 1129(3));
  • the franchisor may, at its own risk, after having given notice of breach to the franchisee, rescind the agreement by notice sent to the latter in case of continuing breach (new section 1226);
  • in any event, rescission can also be requested from the courts (new section 1227);
  • where the acts of performance exchanged were useful only on the full performance of the agreement which has been rescinded, the parties shall restore the whole of what they have obtained from each other (new section 1129(3)); and
  • dispute resolution clauses (arbitration clause in particular), as well as confidentiality and non-disclosure clauses survive the end of the agreement (new section 1230). Case law has also extended the survival of the limitation of liability clause (Supreme Court, commercial division, 7 February 2018). A rescission possibility is now also open to both parties in case of unforeseen economic circumstances not contemplated by the agreement arising during the course of its performance and which place an excessive burden on party (ie, hardship): new section 1195 permits the rescission of the franchise agreement by mutual agreement between the parties in case the franchisee refuses to renegotiate the terms of the agreement.
Termination by franchisee

In what circumstances may a franchisee terminate a franchise relationship?

The rules applicable to termination are the same for franchisors and franchisees (see question 32). In its recent ruling on 28 February 2018, the Paris Court of Appeals ordered a franchisee to pay damages to the franchisor due to wrongful termination, on grounds that ‘the voluntary cessation’ of the franchisee’s activity was not grounds for early termination under the terms of the agreement.

Renewal

How are renewals of franchise agreements usually effected? Do formal or substantive requirements apply?

Franchise agreement are subject to the common rules of contract law and are not necessarily concluded for a fixed-term duration. Generally, parties conclude a franchise agreement for a period of five to 10 years and provides a specific clause specifying the terms and conditions of the renewal of the franchise agreement. Thus, formal or substantive depends on what in indicated in such specific provisions.

Franchisee has usually no automatic right to renew its franchise agreement. Thus, courts often rule that franchisor shall not be liable whether it decides not renew the franchise agreement. (Court of Appeals, Paris, 12 January 2005, 03/02283; Court of Appeals Versailles, 24 January 2017, No. 15/00955) Besides, the franchisor does not have to justify its decision not to renew the franchise agreement and the franchisee usually cannot claim no compensation (Court of Appeals Versailles, 14 March 2017, No. 15/00146). In the case of renewal of a franchise agreement with a fixed-term, in any event, such renewal involves a new franchise agreement and therefore, the franchisor has to provide the franchisee with a new pre-contractual information document.

Refusal to renew

May a franchisor refuse to renew the franchise agreement with a franchisee? If yes, in what circumstances may a franchisor refuse to renew?

Unless otherwise contractually agreed, the franchisee has no right to obtain the renewal of the franchise agreement when the latter has been entered into for a fixed term and been performed through to its term and any notice that is owed contractually or legally has been respected. This principle is now enshrined in section 1212(2) of the Civil Code (‘No-one may require the renewal of the contract’). Accordingly, unless the refusal to renew is unfair or sudden, the franchisor will not be liable for any indemnity payment on the mere basis of non-renewal, even in the absence of cause for non-renewal. The franchisor is under no obligation to give reasons for the decision not to renew. The franchisor’s liability can only be incurred if the decision not to renew the agreement constituted an abuse of right, such abuse having to be demonstrated by the franchisee. Proof of the abuse of the right cannot be brought simply on the basis of the expression of a refusal, the unjustified nature of such refusal, proposing the signature of a different agreement, the mere fact that there is an economic imbalance between the parties or the franchisor’s decision to prioritise the opening of branches in developing the franchise. Lastly, abuse of the right not to renew the franchise agreement may constitute an ‘intentional wrongdoing’ by the licensor (Supreme Court, commercial division, 4 September 2018). Case law in liability cases claiming abusive non-renewal by the franchisor primarily involve the reorganisation of distribution networks.

Transfer restrictions

May a franchisor restrict a franchisee’s ability to transfer its franchise or restrict transfers of ownership interests in a franchisee entity?

A franchise agreement is typically deemed to be concluded intuitu personae, at least as regards the franchisee. This being the case, in the absence of a clause permitting transfers of the franchise agreement, the franchisee cannot transfer the agreement without the consent of the franchisor. It is, of course, possible to contractually restrict the franchisee’s ability to transfer its franchise by requiring, for example, the franchisor’s approval in case of the sale of the franchisee’s business. Contrary to the transfer of the franchise agreement, transfers of ownership in a franchisee entity (change of control), inasmuch as that legal entity remains the same, do not infringe the intuitu personae nature of the franchise agreement. Unless otherwise provided in the franchise agreement, such a change of control in no way requires the prior approval of the franchisee (Lyon Commercial Court, 12 June 2015).

Fees

Are there laws or regulations affecting the nature, amount or payment of fees?

There is no law or regulation affecting the nature, amount or payment of fees.

However, the pre-contractual information document is required to contain the financial details of the agreement proposed by the franchisor, and therefore to specify any up-front entry fee, the amount of the royalties and how they are calculated, as well as the terms of payment. The document should also contain an estimate of the overall investment required to open the franchise.

Case law also posits that the franchisor is required to allocate advertising and promotional fees to advertising and promotion and to provide evidence thereof to the network (Versailles Court of Appeals, 29 September 2015).

Usury

Are there restrictions on the amount of interest that can be charged on overdue payments?

The amount of interest that can be charged on overdue payments is determined by the parties. However, section L.441-6 of the Commercial Code provides a minimum rate of three times the statutory interest rate. If no rate is provided by the agreement, the rate applied will be 10 per cent over the official interest applied by the European Central Bank to its most recent financing operation. While no specific legal provision deals with maximum interest rates, the imposition of unreasonably high rates, in particular having regard to commercial practices, could be considered as manifestly abusive and thus prohibited under section L.442-6 of the Commercial Code. Creditors may also claim damages for any harm and costs they may have suffered as a result of late payments.

Foreign exchange controls

Are there laws or regulations restricting a franchisee’s ability to make payments to a foreign franchisor in the franchisor’s domestic currency?

No. The parties may agree to make payments in the currency of their choice.

Confidentiality covenant enforceability

Are confidentiality covenants in franchise agreements enforceable?

Confidentiality covenants in franchise agreement are enforceable. One of the essential characteristics of the franchise agreement being the transmission of know-how, this supposes the conclusion, if possible, during the negotiation phase, of a confidentiality or non-disclosure agreement. The main objective of a franchise agreement consisting in the reiteration of know-how, the negotiations themselves will involve the sharing of information that is confidential, even if not necessarily corresponding to the know-how itself. For example, this information may enable the franchisee candidate to assess the quality of the method to be transferred, as well as information about the network the candidate contemplates joining. Similarly, most franchise agreements contain, so as to protect the franchisor’s know-how, a confidentiality clause whereby the franchisee undertakes not to disclose such know-how to third persons. In case of litigation concerning the breach of this type of clause (and thus the termination of the franchise agreement by franchisor based on such breach), the courts may restrict its scope of application, for example, by excluding information that is in fact already publicly available. Since the reform of contract law, new section 1230 also expressly provides that confidentiality clauses expressly survive the agreement (new section 1230).

Good-faith obligation

Is there a general legal obligation on parties to deal with each other in good faith during the term of the franchise agreement? If so, how does it affect franchise relationships?

Pursuant to section 1104 of the Civil Code, agreements must be negotiated, concluded and performed in good faith. This general contract rule fully applies to franchise agreements. It implies in particular an obligation of loyalty and cooperation at all stages of the performance of the franchise agreement.

Franchisees as consumers

Does any law treat franchisees as consumers for the purposes of consumer protection or other legislation?

Only consumers and non-professionals benefit from consumer law protection. The rationae personae scope of consumer law is, therefore, sometimes difficult to establish. The legislator defined the notion of consumer for the first time in Act No. 2014-344 of 17 March 2014 (this consumer law is popularly known as the Hamon Law. Previously, it was left to the courts to define what consumer meant. The legal definition established is broad, as is codified in the preliminary section of the Consumer Code as meaning: ‘any natural person acting for purposes other than his commercial, industrial, craft, profession or agricultural activity’. This is the definition of consumer given in article 2-1 of Directive No. 2011/83/EU on consumer rights: ‘any natural person who, in contracts covered by this Directive, is acting for purposes that are outside his trade, business, craft or profession’. Legal persons, therefore, fall outside the scope of definition of ‘consumer’. Order No. 2016-301 of 14 March 2016, which entirely recast the legislative part of the Consumer Code, added to the preliminary section of the Consumer Code the category of ‘non-professional’. The definition of a non-professional was simplified by Act No. 2017-203 of 21 February 2017, which ratified the order and defined a non-professional as ‘any legal person who is not acting for professional purposes’. Accordingly, unlike a consumer, a legal person can benefit from status as a non-professional. However, a non-professional can only benefit from the provisions of Consumer Code that specifically cover non-professionals. The same preliminary section of the Consumer Code defines a professional as ‘any natural or legal person, public or private, acting for purposes related to his commercial, industrial, craft, profession or agricultural activity, including when he acts in the name or on behalf of another professional’. It is not always easy, in the practice of consumer law, to determine who qualifies as a consumer, non-professional or professional. The Supreme Court has adopted a stance in this respect, in two rulings dated 29 March 2017 in which it held that a ‘legal person acting for purposes which are outside its commercial, industrial, craft, profession or agricultural activity’ can qualify as a non-professional and thus benefit from consumer law protection. Accordingly, if a franchisee is a legal person, and acts in the scope of its franchising activity, it will not be protected under consumer law.

Language of the agreement

Must disclosure documents and franchise agreements be in the language of your country?

There is no specific legal requirement that the disclosure document or the franchise agreement be written in French. However, to avoid any future argument that the licensee did not consent to contract on a fully informed basis, it would be safer for the documents and agreements to be drafted in French or else translated into French.

Restrictions on franchisees

Describe the types of restrictions placed on the franchisees in franchise contracts.

There are generally no restrictions on provisions in franchise contracts. A notable exception concerns competition law. See question 45 for further information regarding competition law.

Competition law

Describe the aspects of competition law in your country that are relevant to the typical franchisor. How are they enforced?

The lawfulness of a franchise agreement is determined by reference to French competition rules, and in particular sections L.420-1, 420-3 and L.442-5 et seq of the Commercial Code, and to European competition rules stemming from the Treaty of Rome, having regard to the different restrictions on competition that may be contained in a franchise agreement. These rules are enforceable by French competition authorities and by the courts.

Franchise agreements are covered by a Block Exemption Regulation (REC) dated 30 November 1988 (Regulation No. 4087/88), which was passed following the PRONUPTIA ruling of 28 January 1986 in favour of which the Court of Justice of the European Communities (CJEC, now CJEU) examined the compatibility of the franchise agreement with article 85(1) of the Treaty of Rome (now article 101 TFEU) on restrictions of competition (CJCEC, 28 January, case No. 161/84 PRONUPTIA).

As part of the new approach developed by the European Commission, this Block Exemption Regulation was followed by a General Block Exemption Regulation on 22 December 1999 (No. 2790/99) on vertical restraints applicable to all distribution agreements, the main principles of which were upheld in a second Block Exemption Regulation dated 20 April 2010 (No. 330/2010), which is currently in force for a period of 12 years. This 2010 Regulation is accompanied by Guidelines on Vertical Constraints that serve as a guide for analysing the provisions of the Regulation and which express the European Commission’s position concerning how this text should be interpreted and applies. These Guidelines do not have normative value and the application and interpretation of the Block Exemption Regulation remains, as is the case for all European legislation, a matter for the Court of Justice of the European Union which alone, through its decisions, develops substantive law. On this point, it should be stressed that all of these three European Block Exemption Regulations applicable to franchise agreements have adopted the main principles of franchise law posited by the Court of Justice of the European Community in the PRONUPTIA ruling.

Inasmuch as it can be shown that the clauses contained in the franchise agreement are directly related to the making available of know-how, the use of the trademark and, more generally, the maintenance of the identity and the reputation of the network, based on this landmark decision:

Such clauses should, in principle escape the application of article 101(1) TFEU and section L.420-1 of the Commercial Code punishing anti-competitive agreements and practices;

The franchisor does not need to show positive welfare effects, on balance, within the meaning of article 101(3) TFEU and section L.420-4 of the Commercial Code.

More than three decades after the PRONUPTIA ruling, the favourable treatment of franchises under competition rules still holds true since, in a recent ruling on 20 December 2017 (No. 16-20.500), the commercial division of the Supreme Court reiterated the favourable treatment that should be extended to franchise agreements under competition law, considering their pro-economic and pro-competitive object, holding that ‘in the field of franchising, provisions that establish the control strictly necessary for maintaining the identity and the reputation of the network, identified by the franchisor’s business name or symbol, are not restrictions on competition within the meaning of article 101(1) of the Treaty on the Functioning of the European Union and section L.420-1 of the Commercial Code’, and, more specifically ‘that the exclusive sourcing clause imposed on franchisees was necessary to ensure uniform quality and taste of the products at each of them, manufactured according to the specifications and specific methods [of the supplier], and is therefore a decisive element for the image and the identity of the franchise network’, such that the lawfulness of the clause could not be contested.

Lastly, these principles, driving from the PRONUPTIA ruling, have been codified by industry professionals in the franchise sector since 1972, in a Code of Ethics for Franchising established by the European Franchise Federation (EFF), as subsequently updated and constitute good practices in this sector. It should be stressed that this code, which has been adopted and adapted to the national context by the French Franchise Association, is binding on its franchisor members and is sometimes relied on by the courts as guidance in the cases submitted to them.

Typical provisions in a franchise agreement can be found invalid or unenforceable, or both, on their own or taken together, when they have for their effect to restrict competition, include the following.

Exclusive sourcing clause

The Supreme Court recently considered that ‘the exclusive sourcing clause imposed on franchisees was necessary to ensure uniform quality and taste of the products at each of them, manufactured according to the specifications and specific methods [of the supplier], and is therefore a decisive element for the image and the identity of the franchise network’, the lawfulness of which could not therefore be contested (Supreme Court, commercial division, 20 December 2017, No. 16-20.500).

Right of first refusal clause

Franchise agreements often contain, a right of first refusal (or pre-emption agreement) to the benefit of the franchisor, in case of the sale or transfer of the premises or the business by the franchisee during the term of the agreement and for a specified term thereafter. Provided that this right of first refusal is justified and does not have for its effect to artificially restrict competition, the courts may decide that the transfer of the business by the franchisee is not enforceable against the franchisor and order the substitution of the transferee by the franchisor (Paris Court of Appeals, 7 October 2016; Supreme Court, 26 May 2006). In addition, reference should also be made to the new provisions stemming from Order No. 2016-131 of 10 February 2016 reforming contract law, the general regime of obligations and proof of obligations and, in particular, new section 1123 of the Civil Code. This section introduces the concept of a ‘right of first refusal’ in the Civil Code and provides penalties in case of its breach, namely:

  • strict obligation to make redress for the harm or loss sustained; and
  • the invalidity or substitution of the third-party transferred if the third party ‘knew of the existence of this right and of the beneficiary’s intention to exercise it’.

Post-contractual non-compete clause and covenant not to join another franchise network

Most agreements also place the franchisee, after the end of the agreement, under a non-compete obligation or under an obligation not to become a member of a competitor network. This is justified by the fact that the franchisor legitimately seeks to prevent the know-how shared with the franchisee being used for the benefit of a competitor.

Pursuant to the Guidelines on Vertical Restraints, Block Exemption Regulation No. 330/2010 dated April 20th, 2010 covers both ‘an obligation on the franchisee not to engage, directly or indirectly, in any similar business’ (point 45, a) and, ‘an obligation on the franchisee not to acquire financial interests in the capital of a competing undertaking such as would give the franchisee the power to influence the economic conduct of such undertaking’ (point 45, b).

Since 6 August 2016, date of entry into force of the Macron Law of 6 August 2015, the validity of this clause is subject to the following cumulative conditions (section L.341-2 of the Commercial Code):

  • it must ‘relate to goods and services competing with those covered by the franchise agreement’;
  • it must be ‘limited to the premises and land from which the entity has operated its activity during the term of the agreement’;
  • it must be ‘essential to protect the know-how, which is secret, substantial and identified, transferred in the context of the agreement’; and
  • its duration ‘must not exceed one year’ after expiration or termination of the franchise agreement.

The inclusion of a right of first refusal clause in a franchise agreement - applicable during the term of the agreement and for one year thereafter - combined with a post-contractual non-compete clause could potentially be deemed an anti-competitive agreement, provided that the plaintiff in the proceedings can demonstrate (the burden of proof lying with the plaintiff), based on an analysis of the market and of the economic data, that in practice the right of first refusal clause has for its effect to artificially restrict competition (Supreme Court, commercial division, 3 May 2018, No. 16-27.926).

Courts and dispute resolution

Describe the court system. What types of dispute resolution procedures are available relevant to franchising?

The French court system has two separate orders, administrative courts and judicial courts. The court before which a dispute will be brought depends on the subject matter and the amount at stake.

The judicial or ‘ordinary’ court system comprises civil, commercial and criminal courts. A dispute involving a typical franchise agreement will fall within the jurisdiction of the ordinary courts, of which there are three levels: the commercial court (court of first instance), the court of appeals and the Supreme Court. A franchise dispute may also be subject to arbitration if the franchise agreement contains an arbitration clause or if the parties so decide when the dispute arises.

Mediation as an alternative dispute resolution method is also available.

Arbitration – advantages for franchisors

Describe the principal advantages and disadvantages of arbitration for foreign franchisors considering doing business in your jurisdiction.

The principal advantages are as follows.

The parties may choose one or more arbitrators specialised in the law or in a given field, depending on the specifics of the dispute. For example, an arbitral panel may be composed of one lawyer and two technical specialists or by a lawyer, a businessperson and a technical specialist.

Arbitration is confidential. Hearings are not open to the public. Parties not wishing their case or certain related aspects to become public knowledge have every interest in resorting to arbitration.

Arbitration avoids jurisdictional conflicts between courts, in particular in international disputes, and more generally conflict-of-law issues. It therefore offers greater security than judicial resolution.

Enforcement is possible everywhere.

Arbitral awards have the force of judicial decisions and can be easily enforced abroad through international arbitral conventions to which many countries are signatories.

Arbitration is expeditious.

The time period in which the award must be entered is set by the parties or, otherwise, by the Rules of Arbitration.

Challenges of an arbitral award are limited in scope.

The main disadvantage can be the cost of arbitration.

National treatment

In what respects, if at all, are foreign franchisors treated differently from domestic franchisors?

Foreign franchisors are not treated differently from domestic franchisors.

Pursuant to the provisions of section L.151-1 of Monetary and Financial Code, financial dealings between France and abroad are unrestricted. However, in certain limited sectors, involving national defence or affecting public order or activities that are essential to secure the interests of the country, section L.151-3 of same submits foreign investors to a prior authorisation process. See question 4.