Franchise and competition law

Often a franchisor has invested a lot of time, money and effort in the development of its franchise formula. Obviously, the franchisor wishes to protect the accumulated knowledge, identity and reputation of this formula, among other things by making arrangements with its franchisees and by imposing certain obligations. However, this protection may be at odds with competition law, more in particular with the prohibition of cartels.

The prohibition of cartels prohibits agreements between undertakings that are capable of appreciably restricting competition. Acting in breach of the prohibition of cartels can have far-reaching consequences, such as the nullity of the provision concerned or of the entire franchise agreement. Large fines may also be imposed on both the franchisor and the franchisee.*

*This text will be amended due to the entry into force of the Vertical Block Exemption Regulation.

Prohibition of cartels

The prohibition of cartels is contained in section 6 of the Dutch Competition Act (Mededingingswet) and article 101 of the Treaty on the Functioning of the European Union and prohibits agreements or contacts between undertakings that may appreciably restrict competition. Franchise agreements often contain provisions that may be contrary to this prohibition. Examples are a non-compete clause, an exclusive purchasing obligation, market sharing, price agreements and agreements on online sales.

However, provisions in franchise agreements that at first sight are contrary to the prohibition of cartels, may be necessary for the purpose of safeguarding the franchise formula. It follows from European case law that provisions that are necessary to protect the know-how of the franchisor and the identity and reputation of the franchise formula, do not infringe the prohibition of cartels.

In addition, there is a generic block exemption from the prohibition of cartels. This block exemption contains a 'safe haven' if the market share on the relevant market(s) of both the franchisor and the franchisee does not exceed 30% and the franchise agreement does not contain any hard core restrictions. The European Commission has explained this block exemption in more detail in its guidelines, showing that certain obligations imposed by the franchisor on the franchisee are in principle considered necessary, such as the obligation not to engage in competing business activities and the obligation not to disclose any know-how to third parties.

If a provision from the franchise agreement is considered non-essential to the franchise formula and the provision cannot benefit from the block exemption, the provision or the franchise agreement does not by definition infringe the prohibition of cartels. After all, for there to be an infringement, it still has to be demonstrated that the agreement has the object or effect of appreciably restricting competition.

 

Exclusivity and selectivity

Often the franchisor wants to impose restrictions on its franchisees in the franchise agreement. The franchisor may agree with its franchisee that the franchisee may have a certain customer base or have an exclusive right to sell in a certain territory. A franchisor may also apply certain criteria when selecting its franchisees, thereby creating a selective system. However, the criteria must be closely connected with the nature of the product, be capable of being applied objectively, without discrimination and must not go beyond what is necessary so as to fall outside the scope of the prohibition of cartels.

 

Non-compete

Most franchise agreements contain a non-compete clause. A non-compete clause prohibits the franchisee from producing, purchasing or selling goods or services that compete with the franchise formula. An obligation for the franchisee to obtain more than 80 per cent of its total purchases from the franchisor also falls under the concept of non-compete.

According to the case law and guidelines of the European Commission, a non-compete clause which applies for the duration of the franchise agreement is considered necessary for the protection of the franchise formula. However, it is important in that respect that the clause does not apply for a period of more than five years. A clause concluded for a period longer than five years is not automatically regarded as necessary. The limitation in time does not apply if the franchisee carries out its activities in premises situated on a site owned by the franchisor or leased by the franchisor to a third party. In that case, the non-compete clause may last as long as the agreement.

Stricter requirements apply to a non-compete clause for the period after the expiry of the franchise agreement. Only if the non-compete clause relates to goods or services that compete with the contract goods or services of the franchisor, is limited to the premises and the site where the franchisee was active, is indispensable to protect the transferred know-how and is limited to one year, will the clause be deemed not to infringe the cartel prohibition.

 

Resale price maintenance

Resale price maintenance is said to occur, if the franchisor imposes an obligation on the franchisee to resell a product for a fixed or minimum price. In principle, resale price fixing is a breach of competition law, for the basic principle is that each undertaking is allowed to determine its own price policy. Advertising campaigns are an important exception. A franchisor can apply a fixed resale price in the context of an advertising campaign. After all, for the uniform image of the franchise formula, it may be important to set up a coordinated short-term discount campaign. However, this campaign may last for a limited period only, which in the Netherlands is a maximum of eight weeks. A franchisor may, however, apply maximum prices and recommended retail prices.

 

Location

A location clause obliges a franchisee to operate its business from a certain location approved by the franchisor. It may also be stipulated that the franchisee needs permission to move. A clause of that nature is considered necessary to safeguard the identity and reputation of the formula and is therefore allowed in principle.

 

Online sales

A growing number of franchise formulas is also active online, the basic principle being that everyone, so including franchisees, should be able to make unhindered use of the internet to offer goods or services. Although the franchisor is allowed to restrict active sales by franchisees, it cannot restrict passive sales by the franchisees. This means that a customer from outside the exclusive territory of a franchisee may not be redirected to the website of another franchisee, nor may customers from other territories be refused. Moreover, the franchisor is not allowed to charge extra for products sold online compared with offline sales or to limit the online sales to a maximum.

However, certain restrictions on online sales are allowed. A franchisor can oblige its franchisees to sell products in at least one physical outlet. In addition, the franchisor may impose certain quality requirements on the websites of the franchisees and on the manner of offering and delivering products. An obligation may also be imposed to supply online after-sales services.

 

Conclusion

It is permitted for a franchisor to protect its franchise formula by making certain agreements with, and imposing obligations on, its franchisees. However, this protection must not be in breach of the prohibition of cartels. Given the very far-reaching consequences of acting contrary to the prohibition of cartels, both the franchisor and the franchisee will be well advised to obtain information about the legal validity of the agreements made in the franchise agreement.