Ludwig & Van Dam in De Nationale Franchisegids 2018

An overview by Ludwig & Van Dam, franchise attorneys.

The basis of a franchise relationship is the franchise agreement. This contains a number of conditions that the parties must comply with. The rights and obligations between the parties are laid down in the franchise agreement. In addition to the general regulations arising from the law of obligations, various specific regulations apply to franchise relationships, for example tenancy law, competition law, product liability and intellectual property issues. Furthermore, any disguised employer/employee relationship must be taken into account (fictitious employment risk). In addition, the European Code of Honor on Franchising has been created; a set of conditions with which the franchisor and the franchisee must comply. Franchisors who are members of the Dutch Franchise Association (NFV) are obliged to provide their franchisees with a copy of the Code of Honor and to adhere to the Code of Honor. In recent years, a number of standards have been formulated about how the parties should behave towards each other in the phase prior to the conclusion of the franchise agreement. Parties also have specific responsibilities towards each other after the contract has been concluded. This account takes a closer look at these matters, in the hope that you will be able to benefit from them.

The pre-contractual phase

Forecasts 

The franchisor is obliged to provide the prospective franchisee with correct and complete information in the phase preceding the conclusion of the franchise agreement. After all, partly on the basis of that information, the franchisee decides whether or not to sign the franchise agreement. A franchise agreement has very far-reaching consequences and that decision should be taken well-considered. 

The Code of Honor stipulates that the franchisor must provide the franchisee with “financial estimates or forecasts where available” and that “the figures or the expected income for the individual franchisees (…….) must be objective and not misleading”. In practice, this is one of the most important obligations of the franchisor. Based on case law, the standard has been formulated that a franchisor can be liable to the franchisee for incorrectly forecasted data. This may be the case, for example, if the forecast is based on incorrect assumptions and has ignored negative effects that should have been included in the forecast, while it was not clear to the franchisee, based on the franchisor’s statements or otherwise, or did not need to that the prognosis did not paint a realistic picture. Even when a franchisee insists on an overly optimistic prognosis and the franchisor complies with that request, that does not always absolve the franchisor of this liability. In 2016 and 2017, this doctrine was emphatically confirmed in various judgments of various judges. 

Feasibility study 

Forecasts therefore require a thoroughly prepared and well-executed business location and market research  to be based on. This is also referred to as the “feasibility study”. A feasibility study should in any case consist of an investigation into the local competitive position, the demographic and income-related structure of the customer potential, as well as the foreseeable market development in the entire sector. These requirements can be supplemented per situation. It is therefore important for potential franchisees to check before entering into a contract to what extent the franchisor has met these requirements. Franchisors who want to contract with franchisees would do well to prepare such a feasibility study in good time. It goes without saying that both the franchisee and the franchisor have every interest in the success of the franchisee. It is precisely here that good preparation is half the work. 

The franchise agreement 

Although a franchise agreement should be adapted to the nature of the business to which the franchise activity relates, a number of things are included in almost every franchise agreement: 

Party names and definitions 

There should be no doubt as to which parties enter into the franchise agreement. The nature of the franchise formula must also be clearly stated in the franchise agreement.

Territory exclusivity 

In this, a certain region is exclusively assigned to the franchisee. This does not have to be the case with all franchise formulas. 

Mutual rights and obligations – the monetary compensation

Entrepreneurship 

It must be beyond doubt that the franchisee is an independent entrepreneur in order to prevent the franchisee from being regarded as an employee by the industrial association/implementing agency or the tax authorities, which could imply an obligation for both parties to pay social security contributions. In order to assess whether there is a question of independence or whether there may be a disguised employer/employee relationship (fictitious employment relationship), it must be established on the basis of concrete legislation (policy rules) and jurisprudence. This can also lead to the lapse of various tax deduction options. The independence of the franchisee must be apparent from both the franchise agreement and the actual situation. Prior testing by the tax authorities or trade association is possible and in many cases advisable. 

Exclusive purchasing obligation/non-competition clause/price maintenance 

Many franchise organizations have the practice that the products and/or services in question are wholly or largely obtained from the franchisor or from third parties indicated by the franchisor. A clause regarding this obligation must be in accordance with competition law. For each franchise construction, it must be assessed how this can best be given shape and what the possibilities are. The most recent competition law now allows franchise organizations to agree with the franchisee that the latter will sell the products and/or services in question for maximum consumer prices specified in advance by the franchisor. However, this clause is subject to a number of conditions. 

In addition to the purchase of products, the franchisor will want to ensure that the franchisee does not compete with the franchise organization both during and after the franchise agreement has expired. It is possible to include provisions in this regard within a certain bandwidth in the franchise agreement. These provisions may also not conflict with Dutch and European competition rules. It is recommended that you check this carefully before entering into a contract. 

Duration/duration 

It is customary for franchise agreements to be entered into for a period of five years. The Code of Honor assumes that a franchisee must be able to fully write off or recoup his investments within the agreed term of the franchise agreement. A term of five years is often too short for this. In practice, this is solved by extending the franchise agreement for another five years. However, this may prevent the non-compete clause and the exclusive purchase obligation for competition law reasons. It is therefore wise to check this in advance. Incidentally, it may also be considered, partly in that context, to apply the Dutch Franchise Code to the relationship. 

Handbook 

Usually, a franchisor will have its own handbook in which the formula is described in detail. The franchise agreement may stipulate that the handbook forms part of the agreement. The manual often includes rights and obligations of the parties. Just as the franchise agreement cannot be changed unilaterally, neither can the handbook insofar as the changes are of a far-reaching nature. Finally: the handbook may not conflict with the franchise agreement. 

Transfer arrangement 

The franchise agreement must include an adequate arrangement in case the franchisee wishes to sell his company to a third party. An important question is whether the buyer must also become a franchisee and must meet the franchisor’s selection criteria. Various options are possible in this regard. In any event, care should be taken to ensure that neither party is placed at a disadvantage compared to the other as a result of the transfer arrangement. 

Grounds for termination – compensation 

The agreement must include a comprehensive arrangement in the event that one of the parties does not properly comply with the agreement, goes bankrupt or is otherwise no longer able to fulfill its obligations. The reasons for dissolving the agreement should be the same for both parties as much as possible. Furthermore, termination of the franchise agreement should not be taken lightly. In practice, far-reaching constructions sometimes occur. It is strongly recommended that you study the termination scheme carefully before entering into a contract. This also applies to arrangements included in the agreement regarding the situations in which the parties can claim compensation from each other. 

Dispute settlement 

Finally, the franchise agreement must specify which (court) authority is competent to rule on any disputes between the parties. You can opt for, among other things, the civil court or mediation. 

Farewell arrangements 

In the event of a drastic change to the franchise formula, franchisees may, under certain circumstances, choose to leave the franchise formula and continue their business in another way, if the franchise agreement offers this option. Parties would be wise to anticipate such a situation in their franchise agreement. 

Sale of the franchisee’s business 

In addition to the usual transfer arrangement in a franchise agreement, franchisor and franchisee may choose to include further and sometimes detailed criteria in advance in the franchise agreement that may facilitate the sale of the franchisee’s business. In this way, the value that allows real transfer can be determined in advance, including the interests of the franchise organization and the bankability of the company in question. The profit expectation for the acquiring franchisee should also be considered. When the parties agree on such an arrangement in advance, and include it in the franchise agreement, transfer of the franchisee’s business can be smooth and harmonious in practice. 

General 

The above is not an exhaustive list of subjects that should be regulated in the franchise agreement. However, the subjects mentioned are essential and should in principle not be omitted. In addition, the franchise agreement must be kept up-to-date in connection with changing legislation and new insights in practice. It would therefore be a good idea for the franchisor to have his franchise agreement checked regularly. Before entering into a contract, a franchisee must ensure that the franchise agreement submitted to him is of recent date and meets the insights and requirements of that moment. 

The execution of the franchise agreement – duty of care 

Very recent rulings show that the franchisor is independently obliged to actively provide advice and assistance to the franchisee. This applies even more if the franchisor has provided incorrect information in the phase prior to the conclusion of the agreement and the franchisee, as a result, or for other reasons, ends up in a less favorable situation than might be expected.

A franchisee who sees the problems described here arise, should report this to his franchisor at the earliest possible stage. The franchisor must then do everything possible to turn the tide.  If a franchisor succeeds in tackling the problems adequately, it will not easily be liable. This could include intensive guidance, possibly financial compensation and, in extreme cases, even buying out the franchisee. If the franchisor does nothing or demonstrably fails to do so, it risks being successfully held liable for the franchisee’s lost income and losses. This, however, is by no means a law of the Medes and Persians. Cases often fail due to insufficient evidence or considerable fault on the part of the franchisee, although this does not detract from a franchisor’s duty of care and the need to carry out proper feasibility studies. 

Finally 

As can be seen from the foregoing, there is a lot to consider when entering into a franchise relationship. Nevertheless, setting up and developing a franchise agreement need not be problematic. Parties must do their homework properly. The franchisor should, if possible, provide a clear and substantiated forecast. The franchisee, for his part, must fully and adequately commit himself to his company, keep his costs under control, report any problems to his franchisor in a timely manner and, of course, take the necessary steps himself.

If the franchisor and franchisee proceed as described above, little can go wrong. If that is the case, then a solution that is acceptable to both parties must be sought. Such an approach is very common for the better franchisor. 

Theodore Ludwig and Derk van Dam
Rotterdam, March 2018 

Ludwig & Van Dam Advocaten is the largest law firm in the Netherlands specializing in franchise and other partnerships. She has been market leader in her field for many years. In addition to a specialized consultancy practice, in which franchise organizations are guided in their set-up and reorganisations, the office has an extensive litigation practice, in which conflict management takes place at various levels. This can vary from mediation to litigation for franchisors and franchisees, whether or not in a group context. In addition, the office supervises various chains that enter the Dutch market from abroad and also supervises Dutch chains that further develop their activities on foreign markets. 

For information:
Ludwig & Van Dam franchise attorneys
Parklaan 44, 3016 BC Rotterdam
Telephone: 010 – 2415777, fax 010 – 2415770
www.ludwigvandam.nl
email: info@ludwigvandam.nl