The franchise agreement is a complex contractual architecture, at the crossroads of distribution law and competition law. For companies, it represents a powerful lever for development, but its implementation exposes them to significant legal risks if not properly managed. The central question is how to reconcile the restrictions necessary for the proper functioning of the network with the prohibition of anti-competitive agreements. Our firm, competent to advise you on your franchise agreements, observes that many disputes arise from a misreading of this balance. Before exploring the case law, it is essential to recall that franchising is a form of vertical agreement, the complete guide to which helps grasp the general stakes. This article focuses specifically on how authorities and courts analyse such agreements. For an overall view, understanding the nature and functioning of the franchise agreement is an indispensable prerequisite.

Recognition and regulation of franchising in competition law

Competition law, by its very nature, takes a wary view of agreements between companies that restrict their commercial freedom. Yet franchising, which rests on such restrictions, has found its place. This recognition is the result of a pragmatic economic analysis, considering that the positive effects of the model can outweigh its restrictive aspects.

The favourable approach of the Court of Justice (Pronuptia)

The judgment of the Court of Justice of the European Communities of 28 January 1986, Pronuptia de Paris, is the cornerstone of the competition analysis of franchise agreements. Before this ruling, uncertainty was considerable. The Court drew a fundamental distinction that still structures legal reasoning today. It held that franchising is in itself a pro-competitive model: it enables a franchisor to create a network without having to invest in each outlet, and allows independent entrepreneurs to access a market with the support of a proven brand and know-how.

On this basis, the Court laid down a guiding principle: clauses indispensable to the very existence of this system do not fall within the prohibition on restrictive agreements (now Article 101(1) TFEU). In other words, for franchising to function, certain restrictions are not only useful but necessary. These are clauses pursuing two legitimate objectives: preserving the identity and reputation of the network, and protecting the know-how transmitted by the franchisor.

Clauses that are not competition-restrictive

Following the reasoning in Pronuptia, a series of clauses are considered inherent to the franchise agreement and therefore lawful in principle. They do not form the heart of the competition issue, but define the framework of the collaboration. These include in particular:

  • The franchisee’s obligation to apply the commercial methods defined by the franchisor.
  • The obligation to use the trademark, sign and visual identity of the network.
  • The franchisor’s right to adapt the know-how and commercial methods in line with market developments.
  • The franchisee’s obligation to preserve the brand image of the network.

These stipulations are viewed as the very essence of replicating a commercial success, which is the purpose of the franchise model.

Protecting the identity and reputation of the network

For a franchise network to be effective and recognisable to consumers, it must display a certain homogeneity. This uniformity justifies clauses which, in another context, might be considered problematic. Courts accept their validity as long as they do not go beyond what is necessary to achieve this objective.

Franchisee location clauses

The franchisor may require the franchisee to operate from an approved location and exclusively from that location. Such a clause is lawful. It allows the franchisor to control the territorial coverage of its network and to ensure that outlets comply with the brand’s standards. This is not absolute territorial protection (which is prohibited), but a mere delimitation of the contractual place of operation. The franchisee therefore cannot, on its own initiative, relocate the store or open a second one without the franchisor’s consent.

Exclusive or near-exclusive supply obligations (justifications and limits)

This is one of the most sensitive clauses. The franchisor may require the franchisee to source exclusively or predominantly from the franchisor itself or from suppliers it has approved. The justification is twofold: to guarantee the quality and uniformity of the products or services sold under the sign, and to protect the know-how (for instance, where products incorporate a secret technology or recipe). However, the clause has strict limits. It is valid only if indispensable to maintaining the identity and reputation of the network. Where the same quality objectives can be achieved by simply setting out objective technical specifications which the franchisee could have suppliers of its own choosing comply with, the exclusivity may be held disproportionate and anti-competitive.

The tightness of franchise networks

The franchisor may prohibit the franchisee from selling the contract products to unauthorised resellers outside the network. This clause is intended to ensure that distribution of the products remains within the selective franchise system in place. It is essential to protect the integrity of the network and to prevent products from ending up on parallel markets, which would damage the brand image and the coherence of the commercial strategy. Such a prohibition is therefore generally accepted in case law.

Selection of franchisees and criteria (qualitative and quantitative)

A franchisor is free to choose its franchisees. It may set up a selection process based on objective criteria. These criteria may be qualitative (professional experience, technical skills, ability to run a business) or quantitative (financial capacity, minimum size of the premises). Such selection is the basis of a selective distribution network. Provided the criteria are applied in a non-discriminatory manner to all candidates, the refusal to approve a candidate does not constitute an anti-competitive practice. It is a necessary prerogative to ensure the homogeneity and competence of the network.

Protection of the know-how transmitted

The second pillar justifying restrictions in franchising is the protection of know-how. The franchisor transmits a body of secret, substantial and identified information that gives the franchisee a competitive advantage. For this transfer to make sense, the franchisor must be able to guard against the dissipation of this intangible asset.

Non-compete clauses during and after the contract (duration, territorial scope)

The non-compete clause is a fundamental protection mechanism. Its validity is assessed differently depending on whether it applies during or after the contract.
Throughout the term of the franchise agreement, the prohibition on the franchisee carrying on a competing activity is almost always regarded as valid. It is seen as a straightforward expression of the duty of loyalty and of concentration of effort on operating the franchise.
After the end of the contract, the position is more complex. A post-contractual non-compete clause is lawful only if it meets strict cumulative conditions:

  • It must be indispensable to the protection of the know-how transmitted.
  • It must be limited in time (generally one year at most).
  • It must be limited in space (often to the territory where the franchisee carried out its activity).
  • It must be proportionate to the subject-matter of the contract.

These post-contractual obligations represent a major issue when the franchise agreement ends and must be drafted with extreme precision.

Confidentiality and non-disclosure clauses

As an indispensable corollary of the transmission of know-how, the confidentiality clause prohibits the franchisee from disclosing confidential information received to third parties. This obligation is valid throughout the term of the contract and continues after its termination, without time limit. It is universally accepted as essential, and its breach may entail termination of the contract at the franchisee’s fault as well as actions for damages.

Approval of the transferee of the outlet

When a franchisee wishes to sell its fonds de commerce (going concern, i.e. the business as a whole, including goodwill, lease rights and customer base), the franchise agreement very often includes an approval clause. It gives the franchisor the right to approve or reject the prospective purchaser (the transferee). Such a clause is lawful because it allows the franchisor to ensure that the new network member has the required skills and financial resources. The franchisor thereby protects the longevity and homogeneity of its network. However, a refusal to approve must not be abusive or discriminatory. It must be based on objective and legitimate criteria, linked to the interests of the network.

Hardcore restrictions in franchising and their sanctions

While competition law accepts many restrictive clauses in view of the specific features of franchising, it remains uncompromising in the face of certain practices considered particularly harmful. These « restrictions of competition by object » or « hardcore restrictions » are almost always unlawful and expose companies to heavy financial penalties.

The prohibition on imposed minimum and fixed prices (abundant case law)

The franchisor may under no circumstances impose on the franchisee a fixed or minimum resale price for its products or services. The franchisee is an independent trader and must remain free to determine its pricing policy. Any pressure, threat or constraint aimed at imposing a price level is unlawful. The case law is consistent and severe on this point. This practice must be distinguished from merely recommended resale prices, which are permitted provided they do not, in fact, lead to imposed prices. The distinction is subtle and lies at the heart of the issues surrounding price-setting and the pitfalls of resale at a loss and imposed prices.

Absolute territorial protection

While a location clause is allowed, absolute territorial protection is, by contrast, a hardcore restriction. The franchisor cannot guarantee to a franchisee that no other franchisee, nor the franchisor itself, will make sales (active or passive) in its territory. Such a clause would lead to a complete partitioning of national markets, which is contrary to the fundamental principles of competition law. It is possible to organise limited territorial protection, for example by prohibiting the franchisor and other franchisees from physically setting up or from targeting advertising at the granted territory, but total tightness is forbidden.

The prohibition of cross-supplies between franchisees

Prohibiting franchisees within the same network from selling products to one another is also a hardcore restriction. Such parallel sales within the network help to smooth supply (a franchisee out of stock can source from a colleague) and introduce a form of competition at the distribution level. Preventing these cross-supplies restricts competition and is therefore sanctioned. This freedom to source from other network members must be preserved.

Structuring a franchise network and drafting the contracts that govern it require a careful analysis of competition law. A poorly drafted clause or an unfortunate commercial practice can have significant financial consequences and destabilise the entire network. To secure your development and ensure the compliance of your practices, contact our law firm.

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