Core obligations in the franchise relationship II

Mr Th.R. Ludwig

This is the second article in a short series on some core obligations in the relationship between franchisor and franchisee and how to handle them. The subject of information provision was discussed in the previous edition of this magazine, which included the need for revenue and result forecasts to be based on sound principles. This time, the limitation of liability for forecasts provided (exoneration) is discussed. The next and last article will discuss dispute resolution, including mediation. As in the previous article, the writer now also comes to a number of proposals that attempt to limit and further regulate the liability in the case of forecasts provided.

INTRODUCTION

When limiting the liability of a franchisor towards its franchisee in connection with turnover and/or result forecasts, a provision in the franchise agreement is sometimes invoked whereby the franchisor has stipulated that the projected financial estimate is only an indication and that no rights can be derived from it. Such a clause is usually concluded with a clause that should release the franchisor from claims of a franchisee if turnover and/or operating result deviate significantly negatively from the forecasted picture. Such a clause is in itself powerless. In this connection, reference is made, inter alia, to a judgment of the District Court in Breda, dated 14 April 1998, Prg. 1998, 4967: “Aviti has first of all argued that it cannot therefore be held liable for the forecasted turnover and profit not realized by Het Kinderparadijs because Article 6.1 of the franchise agreement stipulates, among other things: “it is understood that data and predetermined figures of the probability study and the probable income statement are given for information purposes only”. Furthermore, Aviti has referred to article 0.6th bullet point of the franchise agreement, which states: “the franchisee declares to have received full information about the possibilities and requirements of the franchise formula, fine-tuned and tested by “In den Olifant” and have had the opportunity to obtain expert advice”. Aviti’s argument fails. In view of the nature of the franchise agreement and the fact that a feasibility study was carried out by MDR distribution en franchising BVBA on behalf of Aviti into the establishment of an “In den Olifant” shop in Breda, as well as in view of the fact that the report sent to has been drawn up as a result of this feasibility study – and more specifically the forecasts with regard to turnover and profit referred to in this report – Het Kinderparadijs has stated undisputedly, formed the direct reason for Het Kinderparadijs to contract, reasonableness and fairness oppose an appeal to the contract provisions referred to by Aviti”. Such an exoneration simply fails. In the present case, the Court of Appeal in ‘s-Hertogenbosch ruled on 26 November 1996, Prg. 1997, 4675, already stated: “Aviti has denied, by invoking Article 6.1 of the franchise contract, that it would be liable for the forecast figures provided. However, this does not detract from the fact that Aviti – it appears – made a fundamental mistake by basing Breda’s forecasts on its experience with the branches in Belgium”.

INDEPENDENTLY SET UP PROGNOSIS BY FRANCHISEE

The defense that the franchisee has independently drawn up the prognosis and that the negative consequences therefore cannot be attributed to the franchisor seems equally powerless. District Court and Court of Appeal in Den Bosch (Rechtbank ‘s-Hertogenbosch, 25 February 1997, Prg. 1997, 4727 and Gerechtshof ‘s-Hertogenbosch, 2 February 1998, unpublished) consider in so many words “even if it should be assumed that the operating forecast has been drawn up by Groenestein itself on the basis of the turnover data provided by La Venezia, this cannot benefit La Venezia in the context of these preliminary relief proceedings. The President has rightly considered that the introduction by La Venezia of Groenestein to the ING bank and the issuance of the repurchase statement by La Venezia undoubtedly gave Groenestein the legitimate expectation that the aforementioned forecast was realistic, which may be considered decisive for the latter’s decision to enter into the contract’.

It is therefore irrelevant whether or not the franchisee itself has drawn up the offending forecast. Franchisees may rely to a large extent on not only the concrete provision of information, but also the behavior of the franchisor. This does not change if, for example, the franchisee’s own bank points out doubts about the possibilities offered by the franchisor: ABN AMRO bank questioned both the forecasts drawn up by Groenestein and the assumptions on which they were based, TL) cannot lead to a different opinion. After all, it is hard to see why Groenestein should not in principle rely on the knowledge and experience of La Venezia as a franchisor in the sector.” (Court of Appeal in ‘s-Hertogenbosch, 2 February 1998)”.

INITIAL RESEARCH

The possibilities for exoneration are therefore limited and, under circumstances without effects, even unauthorized. This also seems to be the case with a clause that is often circulated in practice, which stipulates that the franchisee must address the franchisor within 3 months after the agreement enters into force if there are defects in the provision of information by the franchisor in the pre-contractual phase. After all, more than once the consequences of errors in the pre-contractual phase only manifest themselves in the longer term. Exoneration will simply be impossible if there is intent or recklessness on the part of the franchisor. If this is not the case, the free signing options must be related to what could be expected in terms of efforts made by the franchisee in the pre-contractual phase. The franchisee’s self-limited duty of investigation may be broadened if the franchisor fully implements the “Supplement to the European Code of Honor on Franchising”, a paragraph on “pre-information to prospective franchisees.” Both the franchisor and candidate franchisees would do well to deal extensively with sub 3 and sub 7 of Article 3 paragraph 3. These subs stipulate that the franchisor shall provide to the franchisee: “a complete recent overview of affiliated franchisees, their business addresses and telephone and fax numbers”; and (sub 7) must provide “bank references”. The purpose of providing addresses should be clear; the franchisee is given the opportunity to inquire about the quality of the franchise organization. To avoid such an opportunity being limited to meeting a single benevolent franchisee, it would be desirable to provide insight into the organizational and financial status of existing franchise locations as well as the franchise organization as a whole. Such an approach is very common in several states in the United States. Such an initial investigation may reduce uncertainties in the pre-contractual phase. When the franchisor and franchisee then jointly gain insight into forecasts and turnover and result developments of existing franchisees, a true and fair view of the possibilities may arise, taking into account the suggestions in a and b in the previous article of this magazine. This stretches the franchisee’s obligation to investigate as a result of the fact that his knowledge of the franchise organization increases considerably in the pre-contractual phase, with the necessary benevolence and cooperation of the franchisor. The candidate franchisee thus does not have to conduct lengthy and costly independent research and is guided by his future business partner, who is dominant in the intended franchise relationship. With such an approach, the risk may be limited to errors of judgment in determining the local possibilities.

INSURANCE

Furthermore, a good franchisor would be wise to take out insurance against incorrect financial forecasts. Such assurance is unusual, but by no means impossible. It should be noted that this notion is somewhat experimental in nature; some research has shown that the insurance referred to here is very feasible, but is not or hardly applied. In practice, therefore, further concretization still needs to take place.

COMBINED EXONERATION

Whether the combined exoneration described above, consisting of an initial investigation and adequate insurance, can be beneficial remains dependent on the circumstances, for example on the way in which the parties treat each other when a significant negative discrepancy occurs between forecast and turnover and result. Furthermore, the disappointing results should not stem from other causes. In order to further regulate the practice with regard to this theme, I propose to add sub c and d to sub a and b, as proposed in the previous article of this magazine, as follows:

c. the franchisor limits its liability with regard to the financial prognosis used by the franchisee as a starting point for the franchise relationship with the franchisor’s consent, to those consequences that can be directly traced back to causes that lie in the unsoundness of the starting points of the assumptions used by the franchisee. prognosis, arising from specific local circumstances, in which the parties jointly conducted an initial investigation and referred to the results thereof.

d. The franchisor furthermore limits its liability to that amount to which the liability insurance taken out by it gives entitlement, increased by the deductible under that insurance. The restriction does not apply in the event of intent or willful recklessness. A copy of the current policy with conditions is available for inspection at the franchisor.

Mr Th.R. Ludwig is a lawyer in Rotterdam