Franchise Contract

Definition Franchise

In article 911 of Book 7 of the Dutch Civil Code the franchise agreement is defined as follows:

an agreement whereby the franchisor, in exchange for payment, grants the right to, and imposes the obligation on, a franchisee to operate a franchise formula in the manner to be determined by the franchisor, regarding the production or sale of goods or the provision of services’.

And what is a franchise formula?

Article 911 of Book 7 of the Dutch Civil Code also defines the term franchise formula:

an operational, commercial and organisational formula for the production or sale of goods or the provision of services, which determines a uniform identity and appearance of the franchise businesses within the chain in which this formula is applied, and which in any case includes

1°. a trademark, model or trade name, corporate identity or design; and

2°. know-how, being a body of practical information, not protected by any intellectual property rights, arising from the experience of the franchisor and from the research carried out by that party, which information is confidential, material and identifiable;

Any form of cooperation in the Netherlands that meets this (broad) definition of the term 'franchise agreement' is governed in full by the Franchise Act.

The Franchise Act sets out a number of rights and obligations on the part of the franchisor and the franchisee and furthermore lays down the provisions that must ‘in any case’ be included in a franchise agreement. This concerns mandatory law, which means that the provisions concerned may not be derogated from to the detriment of the franchisee. If such should nevertheless be the case, those exceptional provisions will be null and void.

Below is a brief explanation of a number of aspects that should be provided for in the franchise agreement.

 

Who are the parties?

At the time a contract is concluded, it is essential to determine with which party the contract is entered into. The most common parties in a franchise are the one-man business, the general partnership and the private limited company.

In the case of a one-man business or a general partnership with one or more natural persons as partners, the franchisee is bound as a natural person, meaning that the franchisor may have recourse against all of the natural person’s assets if obligations are not met.

However, if the contracting party is a private limited company, it will in principle be this private limited company with its separate capital only that may be sued by the franchisor for the performance of the former’s obligations. If the franchisor wishes to bind the underlying natural person/shareholder as well, this will have to be provided by contract.

In that respect the franchisor should moreover be aware that, in the course of the cooperation, the franchisee/natural person may still transfer its business to a private limited company. If the franchisor agrees to this, tacitly or otherwise, this may lead to a change of the contracting party (contract takeover) and even to a situation where, without the franchisor being aware of this, the contracting party ultimately turns out to be an empty shell, instead of the original natural person. However, all this may be overcome relatively easily by including a so-called joint and several liability clause in the franchise agreement.

 

Provision of information

For most franchise organisations, it is essential to attract new franchisees. More franchisees usually means more income, not to mention all sorts of other advantages. In the pre-contractual phase, the franchisor will provide the prospective franchisee with all kinds of information that is supposed to persuade the eligible prospective franchisee to join the organisation. When the Franchise Act entered into force, articles 913 f.f of Book 7 of the Dutch Civil Code also set down a variety of information the franchisor is obliged to share. To avoid any subsequent discussions about the correctness of the information and the conclusions the prospective franchisee could draw from, for example, information concerning any projected financial results, it is wise to specify in the franchise agreement the purpose for which certain information was provided. By so doing, it may for example be possible to limit the risk of a franchisee successfully claiming afterwards that it was misled when it concluded the franchise agreement.

 

Territory and exclusivity

In most franchising organisations, the franchisees are allocated a territory of their own. This may be an exclusive territory, but it may, for example, also be a non-exclusive, primary focus area. It is important that the agreements which are made are clearly set down in writing. It often happens with starting franchise organisations that initially the territories are extensive, but that they are subsequently down-sized. Doing so is permitted, but any such changes must be specified in detail. Particularly in the case of exclusivity, it is important that the territories assigned to the franchisees have sufficient potential for the franchisee to generate sufficient turnover. This is often an issue where the interests of the franchisor and those of the franchisee do not run parallel. As a rule, the franchisor usually wants to keep the number of territories limited, also with a view to maximizing the turnover in those territories, whereas the franchisees, on the other hand, want the territories to be as large as possible. It is the franchisor's responsibility to consider this carefully, to conduct a thorough investigation and in all reasonableness to grant the franchisee a territory with sufficient earning capacity, something that may become even more relevant with the introduction of the term 'good franchisor' in the Franchise Act.

 

Independence

A franchisee operates a business at its own expense and risk and must register as a company with the Chamber of Commerce. Almost every franchise agreement contains all kinds of provisions emphasizing this independence. In some franchise organisations, however, the franchisees are less 'independent' than is suggested by the franchise agreement. If, for example, a franchisee/self-employed person runs a one-man business, is expected to perform certain activities in person, does not have any business premises of its own, is given all kinds of instructions by the franchise organisation and if the franchisee actually runs a limited entrepreneurial risk, this might give rise to a serious risk, since the Tax Authorities may take the view that, although formally no employment contract has been concluded, in practice an employment relationship or fictitious employment relationship nevertheless exists. This may have serious consequences for the franchisor, since employer's contributions or all kinds of wage taxes may still have to be paid with retroactive effect. It is therefore advisable to adjust the formula to this and to lay down in the contract that the franchisee does not have to perform the work personally, that certain costs incurred regardless of the turnover are to be charged to the franchisee (risk) and, in case of doubt, to consult the Tax Authorities beforehand. More about this matter may be read here.

 

Intellectual property rights

As a rule, the franchise agreement also contains a licence. After all, the franchisee is granted the right by the franchisor to operate a business by using the formula, subject to certain conditions. Part of the formula are the name and/or other distinctive signs. Often the franchisee is also given access to all sorts of documents drawn up by the franchisor. You are advised to make sure that the franchise agreement properly specifies which party is entitled to which rights. In that respect it may be advisable to prohibit the franchisee from registering all or part of the franchisor's intellectual property rights in the franchisee’s own name.

 

Privacy

In the Netherlands legislation on privacy, such as the GDPR, is strict. Since many franchisors wish to have access to privacy-sensitive information (for example the franchisee's customer database or its prospects), proper arrangements must be made in this regard. Who is the data processor? Who is the controller? To that is added that the franchise organisation may get into serious trouble if a franchisee fails to observe the privacy laws. If the Dutch Data Protection Authority (Dutch DPA) receives a complaint about the conduct of a franchisee, in many cases the entire franchise organisation will become the subject of an investigation. This may be prevented by making appropriate arrangements.

 

Records, inspection and insurance

A franchisor does not want its franchisees to get into trouble. It furthermore wants to know how its franchisees are doing, so as to enable adjustments to be made and the results of the individual franchisees to be compared. Many franchise organisations furthermore have a system whereby exclusive purchasing obligations apply and/or the franchisees are obliged to pay a certain turnover-related fee. Most franchisors therefore have an interest in proper records being maintained by, and in being provided with, the opportunity to inspect these, both during the term of the franchise agreement and for a limited period afterwards. If something should go wrong, it is important for the franchisee to be adequately insured. It is therefore important to make appropriate arrangements on these points in the franchise agreement.

 

Range of products

Part of the franchise formula is as a rule a certain product, service or range of products and/or services. This range of products often constitutes the basis of the existence of the franchise organisation. It is for this reason that the franchise agreement must properly specify which products/services the franchisee is allowed or obliged to sell and from which party or parties the relevant products and/or services in question must be purchased. If the franchisor obliges the affiliated franchisees to purchase the products/services from the franchisor or from a supplier to be designated by the franchisor, the franchisor must have a certain legitimate interest in demanding this. Such an interest may for example consist in obtaining collective purchasing benefits, such as the price, but also in uniformity, inspection, quality or reliability of delivery. It may also be advisable to emphasise this interest in the agreement.

 

Goodwill

The Franchise Act obliges parties to include a provision in the franchise agreement that regulates compensation of accrued goodwill, insofar as such goodwill is reasonably attributable to the franchisee. For example, the parties may include a specific method of calculation in the agreement. It is also possible for the parties to lay down in the franchise agreement in what way and at what future moment such goodwill, if any, will be decided on and allocated. Thus, the parties might agree that any goodwill will be determined and allocated by an expert at some point in the future.

However, the obligation to pay compensation only applies in the event that the franchisor takes over the franchise enterprise from the franchisee, following which the franchisor may itself decide whether it will continue the franchise enterprise as a branch of its own, of if wishes to transfer the franchise enterprise to a new franchisee. Only in this case will the franchisor benefit from any goodwill accrued by the exiting franchisee. The exiting franchisee should receive compensation from the franchisor for any goodwill attributable to it, so when a franchisee (with the franchisor’s permission) transfers the franchise enterprise to a new franchisee, compensation of any existing goodwill is irrelevant. The goodwill will in that case have been factored into the takeover price.

 

Prices

Many franchise agreements contain a provision about the prices to be charged by the franchisee when selling the products and/or services. In many franchise organisations, this is also a matter which the franchisor would like to have a grip on or even control of. However, it is important to know that at this point competition law plays an important role. Under competition law, a franchisor can suggest certain recommended retail prices to franchisees or incorporate a price ceiling, but it may NOT impose fixed or minimum prices. A franchisor who nevertheless does so runs a considerable risk of being fined by the competition authorities and/or of receiving claims for damages from the franchisees.

 

Non-competition clause and non-solicitation clause

Most franchise organisations stipulate that the franchisee shall refrain from carrying out any competing activities for at least the duration of the franchise agreement. As a rule, such a clause is formulated in broad terms. The Franchise Act lists the requirements that have to be met by a post-contractual non-competition clause in the franchise agreement. For example, the non-compete period must not exceed a period of one year after the end of the franchise agreement and its geographical scope may not extend beyond the territory in which the franchisee has operated the franchise formula. In addition, the clause may relate only to goods or services that compete with goods or services covered by the franchise agreement, in addition to which the clause must be in writing and indispensable in terms of the protection of know-how. If a non-competition clause in the franchise agreement does not meet the conditions set forth in the Franchise Act, it will be null and void. It may furthermore be important to include a non-solicitation clause, in which respect it is advisable to specify why this clause is important and to properly define what is meant by a relation.

 

Penalty clause

A penalty clause is indispensable in virtually every franchise agreement. The purpose of a penalty clause is twofold. By imposing a penalty on the breach of certain provisions that are crucial to the franchise organisation, a threshold is created. The risk of forfeiting a penalty may stop a franchisee who does not act in good faith from committing such a breach. To this is added that in certain cases it is extremely difficult to prove that damage has been sustained, which in its turn may encourage committing such breaches. Examples are the breach of a non-solicitation clause or a confidentiality clause. What is the damage suffered by the franchisor if a customer indicates that it no longer wishes to do business with the franchise organisation after all? What is the damage if confidential information is shared with third parties? A penalty clause enables a party to fix the damage. However, a franchisor should carefully consider which provisions are to be breached in order for a penalty to be imposed, while it should furthermore be borne in mind that a judge can always moderate the amount of a contractual penalty. Another issue is the question to what extent the introduction of the legal term 'good franchising practices' is going to play a role in this respect.

 

Interim changes

Many franchise agreements contain so-called unilateral amendment clauses. Such a clause allows the franchisor to one-sidedly amend the franchise agreement in the course of its term. After all, the franchisee has agreed to such changes in advance. Since this may lead to undesirable situations for the franchisees, the so-called right to consent has been introduced by article 921 of Book 7 of the Dutch Civil Code. When a change to the franchise formula causes a loss of turnover or forces the franchisees to make additional investments in excess of the agreed threshold amount, a majority of the franchisees established in the Netherlands, or the 'affected' franchisees, must agree to this change. In order not to have to request permission for every amendment to the formula that will have a certain impact, it is advisable to include a threshold value regarding certain changes within the franchise formula. If the financial impact of a change remains below this maximum, no consent is required.

 

Duration

The franchisor determines the duration of the franchise agreement for its franchise organisation. In order to prevent being accused of arbitrariness, it is recommended to work with a kind of standard duration, which, under equal circumstances, applies to all the franchisees. It is possible to deviate from this, for example within the context of doubts surrounding a renewal. Another important basic principle is that the duration of the franchise agreement must be long enough for the franchisee to at least be able to earn back its investments. In practice, a duration of 5 years is often used, in which respect the duration of the lease should also be considered. If, for example, the franchisee leases retail space, 5 years is a common period for the lease. As a rule, it is recommended to have the duration of the franchise agreement coincide with the term of the lease, particularly if the tenancy rights are linked to the capacity of franchisee of the formula concerned.

 

Tenancy rights

If the location is important and if there is a combination of franchising and (sub)leasing, a complex situation often arises. The franchisor wants the franchisee to vacate the premises as soon as the franchise agreement ends, but the franchisee, as a lessee, in principle enjoys security of tenure. It is important for the mutual rights and obligations to be laid down properly. More about this matter may be read here.

 

Franchise consultations

The Franchise Act stipulates that consultations should take place at least once a year. This is the minimum frequency. Most franchise organisations have a (formal or informal) franchise council, which is a consultative body. In addition, the somewhat larger franchise organisations often have a franchise association. A franchise association represents the interests of the franchisees. More about this matter may be read here. The Franchise Act (and in particular the right of consent contained in it) implies that having a franchise association within the organisation may be attractive for franchisors as well. After all, if the members of the association are bound by majority decisions, the franchisor only needs to obtain the support of the majority of the members when introducing a change for which consent is required.

 

General

Drafting a franchise agreement requires specialist knowledge. Obviously, a proper model contract is an excellent starting point, but there are many forms of franchising and almost every franchise organisation has a number of characteristics that are very specific to the formula in question. The difference between a mediocre contract, a good contract or a very good contract is almost always in the details. It is precisely those details that are often difficult to distinguish for a person with no legal knowledge and as a rule the quality of a contract does not transpire until discussions or even a dispute arise, for that is the moment when the contract consulted. A good and transparent contract will also prevent disputes from arising. The clearer the arrangements, the smaller the chance that a discussion will escalate into a dispute.