One of the key components of any franchise agreement is the transmission of know-how by the franchisor to the franchisee. Without this, the agreement may be held null and void or requalified as a mere distribution agreement. In a June 8 2017 decision,(1) the Supreme Court held that the absence of any pilot outlet run by the franchisor does not amount to a lack of know-know transmission.
A franchise agreement was entered into between two French companies in relation to know-how dedicated to assisting small businesses with management tasks (the 'Rivalis concept'). The franchisee – which eventually became bankrupt and sought the cancellation of the franchise agreement – claimed, among other things, that the agreement was null and void because the franchisor had not operated a pilot outlet.
On September 30 2015 the Court of Appeal declared the franchise agreement to be null and void. The court held that the franchisor had failed to communicate any know-how to the franchisee, as no pilot outlet had been made available to the latter; the existence of such an outlet is necessarily decisive to assess the relevance of such know-how and its efficiency. The franchisor therefore brought the case before the Supreme Court.
On June 8 2017 the Supreme Court reversed the Court of Appeal's decision. The court held that the latter had failed to consider the franchisor's argument that it had provided the franchisee with training sessions during which specific know-how had been transmitted.
Some soft law instruments refer to pilot units. AFNOR Standard Z 20-000 of July 16 1987, issued by the French Standardisation Association (AFNOR), defines a 'pilot outlet' as an operation centre in which the franchisor's know-how is implemented and which shows positive results over at least 12 months. Further, the European Code of Ethics for Franchising provides that the franchisor must have successfully operated a business concept for a reasonable time and in at least one pilot unit before starting its franchise network.
However, none of these instruments are legally binding. AFNOR Standard Z 20-000 has never been approved by the government. Therefore, as held by several lower courts, franchise agreements may not be declared null and void for failing to meet such standards, unless the parties have contractually decided to make them binding. The same applies to the European Code of Ethics for Franchising.
Moreover, no legal provision on franchising expressly refers to pilot units or requires the franchisor to run a pilot outlet under French law. This raises the question of whether the transmission of know-how (which is key in any franchise agreement) can occur when no pilot outlet is run by the franchisor.
This is the Supreme Court's first decision on this legal issue. Previously, only a few decisions had been rendered by the lower courts. In this decision, the Supreme Court clearly considered that a franchisor is not legally required to run a pilot outlet: communication of know-how may still occur without a pilot outlet – for instance, through training sessions.
Of course, the franchisor must not mislead the franchisee regarding the absence of any pilot outlet. Indeed, in other matters, the lower courts have held that the franchise agreement was valid even in the absence of a pilot outlet, as the franchisee was fully aware that there was no outlet, that its own outlet would be the first one and that the concept had not been previously tested. On the other hand, a lower court declared a franchise agreement null and void because the franchisee would have never agreed to it had the franchisor let the franchisee known that it had not previously operated any pilot outlet.
In short, running a pilot outlet may be highly advisable from an economic perspective, but it is not a legal requirement. The franchisor creating a concept is free to determine its own development strategy, having regard to the risk of being copied by others. Likewise, as an independent business, a franchisee may be interested in taking part in the launch of an innovating concept and being the first one to settle in the business and the relevant area.
In any event, if the franchisor has never operated a pilot outlet, it must ensure that the franchisee is entering into the franchise agreement with full knowledge of the facts and the novelty of the system.
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For further information on this topic please contact Raphael Mellerio or Bertrand Baheu-Derras at Aramis Law Firm by telephone (+33 1 53 30 7700) or email (firstname.lastname@example.org or email@example.com). The Aramis Law Firm website can be accessed at www.aramis-law.com.