Franchising - Germany

Background

It is sometimes inevitable that parties to a franchise agreement will pursue a conflict of interests in court. The reasons why franchisors seek recourse in court are manifold: the franchisor may, for example, seek to compel the franchisee to make certain changes or simply comply with agreed standards (eg, to uphold a direct debit authorization or employ a certain cash desk system). In such cases the franchisor must base its claims on the provisions of the franchise agreement, with the prerequisite that the corresponding clause is valid.

Clauses of franchise agreements are standard terms and conditions which are governed by specific provisions. A clause is valid provided it does not unreasonably prejudice the franchisee (Section 307 of the Civil Code). Courts will examine for this when reviewing the terms of the franchise agreement from the perspective of the law on standard terms and conditions. Should the court deem a clause to be unreasonable, that clause alone will be invalid; however, the remaining clauses of the franchise agreement will remain in full force and effect (Section 306 of the Civil Code).

In practice, there are numerous cases in which a court objects to a number of clauses in a franchise agreement. The reason in some cases is an inadequate knowledge of franchise law, but sometimes also carelessness in the wording of the specific franchise agreement at issue. A particular role is played in this context by franchise agreements which are based on model agreements deriving from foreign law, such as US or English law. Such (merely translated) model agreements frequently contain a considerable number of clauses which - although lawful in their country of origin - cannot be enforced under German law.

If the court identifies a large number of unreasonable clauses, which may even be in violation of antitrust law, the consequences can be dramatic: the court could hold the entire franchise agreement to be against good morals (Sittenwidrigkeit) and therefore invalid (Section 138 of the Civil Code). In comparison to unreasonableness, the defence resulting from a violation of good morals is the strongest under the law on standard terms and conditions: it does not merely result in the extraction of the individual invalid clause, but rather quashes the entire agreement. This is shown in the following example.

Practical Example

Over a long period of time, a franchisor entered into franchise agreements with approximately 50 franchisees. The agreements were based on a uniform model agreement that was used from the outset. The franchisor terminated one of the agreements with immediate effect for good cause because the franchisee also acted for a competitor, in breach of a contractual competitive restriction. The franchisor subsequently sued the franchisee for damages for lost (minimum) franchise fees and advertising charges; the franchisor would have received the fees if the franchise agreement had been duly performed.

At first instance the regional court did not object to the competitive restriction imposed on the franchisee - the complaint should therefore have succeeded. However, the court took the view that due to the large number of unreasonable clauses in the franchise agreement (eg, regarding the scope of the control rights and the franchisor's right to share in decision-making, and the allegedly excessive term), the entire agreement was invalid. The court therefore dismissed the complaint and expressly held that the agreement was, in its entirety, against good morals.

Fortunately, the court of appeal did not concur with the findings of the regional court and held that the franchise agreement - despite a number of clauses giving rise to reservations - was by no means against good morals. However, the matter backfired, at least at first instance: instead of obtaining a favourable judgment, the plaintiff seeking justice was confronted with a finding that its franchise agreement was null and void. This meant that all franchise agreements in that system were simultaneously exposed to the risk of invalidity, a consequence which forced the franchisor to turn to the court of appeal.

Comment

The above example shows that clauses which are unreasonable or give rise to reservations do constitute a risk for the entire franchise agreement and, hence, for the entire franchise system. The court not only may object to an individual clause, but may instead declare the entire agreement to be contrary to good morals, and hence invalid, because it contains too many unreasonable clauses. This means that a number of minor violations of the law on standard terms and conditions could add up and - at least from the perspective of a court - result in a verdict of unconscionability and the infringement of good morals respectively.

Admittedly, more recent judgments especially indicate that the higher regional courts at least endeavour to keep things in perspective and are not so stringent as regards a violation of good morals. It is nonetheless worrying when a court of first instance declares an agreement null and void and it is not until the court at the next instance (possibly) takes a closer look that it is clarified that the number of unreasonable clauses is in fact far fewer and a verdict of an infringement of good morals is unjustified. For this reason it is important that franchise agreements are consistent with the law on standard terms and conditions, in order to avoid unnecessarily jeopardizing the potential enforcement of rights against the franchisee.

International Law Office