The franchise contract is a complex contractual structure at the crossroads of distribution law and competition law. For companies, it represents a formidable lever for development, but its implementation exposes them to significant legal risks if it is not properly mastered. The key question is how to reconcile the restrictions necessary for the proper operation of the network with the prohibition on anti-competitive agreements. Our firm, competent to advise you on your franchise agreementsThe case law on franchising, however, shows that many disputes arise from an incorrect assessment of this balance. Before exploring the case law, it is essential to remember that franchising is a form of "franchising".vertical agreement, whose complete guide makes it possible to grasp the general issues. This article focuses specifically on the way in which the authorities and the courts analyse these agreements. For an overview, understanding the the nature and operation of the franchise contract is an essential prerequisite.
Recognition and supervision of franchising in competition law
Competition law is inherently suspicious of agreements between companies that restrict their commercial freedom. However, franchising, which is based on such restrictions, has found its place. This recognition is the result of a pragmatic economic analysis, which considers that the positive effects of the model may 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 of Parisis the cornerstone of the competitive analysis of franchise agreements. Prior to this decision, there was a great deal of uncertainty. The Court made a fundamental distinction that still shapes legal reasoning today. It ruled 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 independent entrepreneurs to access a market with the support of a tried and tested brand and know-how.
On the basis of this finding, the Court established a guiding principle: clauses which are indispensable to the very existence of this system do not fall within the scope of the prohibition on restrictive agreements (now Article 101(1) TFEU). In other words, for franchising to work, certain restrictions are not only useful, but necessary. These are clauses aimed at two legitimate objectives: preserving the identity and reputation of the network, and protecting the know-how passed on by the franchisor.
Non-restrictive competition clauses
Applying the reasoning of the PronuptiaA number of clauses are considered to be inherent to the franchise contract and therefore, in principle, lawful. They do not constitute the core of the competitive problem, but define the framework of the collaboration. They include
- The obligation for the franchisee to apply the commercial methods defined by the franchisor.
- The obligation to use the network's brand, sign and visual identity.
- The franchisor's right to adapt the know-how and commercial methods to changes in the market.
- The franchisee's obligation to preserve the network's brand image.
These stipulations are seen as the very essence of replicating commercial success, which is the aim of the franchise model.
Protecting the network's identity and reputation
For a franchise network to be successful and recognisable by consumers, it must have a certain uniformity. This uniformity justifies clauses which, in another context, might be considered problematic. The courts accept them as valid 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 conduct its business exclusively from an approved premises. This clause is lawful. It enables the franchisor to control the network's territorial coverage and ensure that the outlets comply with the brand's standards. It is not a question of absolute territorial protection (which is prohibited), but of a simple delimitation of the contractual place of operation. The franchisee cannot, therefore, move his shop or open a second one on his own initiative without the franchisor's agreement.
The exclusive or quasi-exclusive supply obligation (justifications and limits)
This is one of the most sensitive clauses. The franchisor may require the franchisee to obtain all or a large majority of its supplies from the franchisor or from suppliers that the franchisor has referenced. There are two reasons for this: to guarantee the quality and uniformity of the products or services sold under the brand name, and to protect know-how (for example, if the products incorporate a secret technology or recipe). However, this clause has strict limits. It is only valid if it is essential to maintaining the network's identity and reputation. If the same quality objectives can be achieved simply by defining objective technical specifications that the franchisee could ensure are respected by suppliers of his choice, then the exclusivity may be deemed disproportionate and anti-competitive.
The watertightness of franchise networks
The franchisor may prohibit the franchisee from selling the contractual products to unauthorised resellers outside the network. The purpose of this clause is to ensure that the distribution of the products remains within the selective franchise system that has been set up. It is essential in order to protect the integrity of the network and prevent products from finding their way into parallel markets, which would damage the brand image and the coherence of the commercial strategy. This prohibition is therefore generally accepted by case law.
Selection of franchisees and criteria (qualitative and quantitative)
Franchisors are free to choose their franchisees. They can set up a selection process based on objective criteria. These criteria may be qualitative (professional experience, technical skills, ability to manage a business) or quantitative (financial capacity, minimum size of premises). This selection is the basis of a selective distribution network. As long as the criteria are applied in a non-discriminatory way to all applicants, refusal to approve an applicant does not constitute an anti-competitive practice. It is a necessary prerogative to ensure the homogeneity and competence of the network.
Protecting the know-how passed on
The second pillar of the justification for restrictions in franchising is the protection of know-how. The franchisor transfers a body of secret, substantial and identified information that gives the franchisee a competitive advantage. For this transfer to be meaningful, the franchisor must be able to protect this intangible asset against dissipation.
Non-competition clauses during and after the contract (duration, territoriality)
The non-competition 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 considered valid. It is seen as a simple expression of the obligation of loyalty and concentration of efforts on the operation of the franchise.
After the end of the contract, the situation is more complex. A post-contractual non-competition clause is only lawful if it complies with strict cumulative conditions:
- It must be essential for the protection of the know-how passed on.
- It must be limited in time (generally a maximum of one year).
- It must be limited in space (often to the territory where the franchisee used to operate).
- It must be proportionate to the purpose of the contract.
These post-contractual obligations represent a major challenge for termination of the franchise contract and must be written with extreme precision.
Confidentiality and non-disclosure clauses
An essential corollary of the transfer of know-how, the confidentiality clause prohibits the franchisee from disclosing confidential information received to third parties. This obligation is valid for the entire duration of the contract and continues after its termination, without any time limit. It is universally accepted as being essential, and its breach may result in the termination of the contract to the detriment of the franchisee, as well as proceedings for damages.
Approval of the shop transferee
When a franchisee wishes to sell his business, the franchise contract very often includes an approval clause. This gives the franchisor the right to approve or reject the prospective buyer (the transferee). This clause is lawful because it enables the franchisor to ensure that the new member of the network has the required skills and financial resources. In this way, the franchisor protects the continuity and homogeneity of his network. However, a refusal to grant approval must not be abusive or discriminatory. It must be based on objective and legitimate criteria, linked to the interests of the network.
Hard-core restrictions in franchising and their penalties
Although competition law admits many restrictive clauses in the name of the specific nature of franchising, it remains intractable in the face of certain practices considered to be particularly harmful. These "restrictions of competition by object" or "hardcore restrictions" are almost always illegal and expose companies to heavy financial penalties.
Prohibition of minimum prices and fixed prices (abundant case law)
Under no circumstances may the franchisor impose a fixed or minimum resale price on the franchisee for its products or services. The franchisee is an independent trader and must remain free to determine his pricing policy. Any pressure, threat or constraint aimed at imposing a price level is illegal. Case law is consistent and severe on this point. This practice is to be distinguished from sales prices that are merely recommended, which are authorised as long as they do not, in practice, result in imposed prices. The distinction is subtle and lies at the heart of the problems of setting prices to avoid legal pitfalls.
Absolute territorial protection
While the location clause is permissible, absolute territorial protection is a hardcore restriction. The franchisor cannot guarantee a franchisee that no other franchisee or the franchisor himself will make sales (active or passive) in his territory. Such a clause would lead to a total 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 setting up shop or carrying out targeted advertising in the franchised territory, but total sealing is prohibited.
Prohibition of retrocessions between franchisees
Prohibiting franchisees in the same network from selling products to each other is also a hardcore restriction. These parallel sales within the network make it possible to improve the flow of supplies (a franchisee who is out of stock can buy from another franchisee) and introduce a form of competition at distribution level. Preventing these retrocessions limits competition and is therefore punishable. This freedom to obtain supplies from other members of the network must be preserved.
The structuring of a franchise network and the drafting of the contracts governing it require a detailed analysis of competition law. A poorly drafted clause or an unfortunate commercial practice can have major financial consequences and destabilise the entire network. To secure your development and ensure that your practices are compliant, contact our law firm.
Sources
- Commercial Code, in particular the provisions on competition and distribution contracts.
- Treaty on the Functioning of the European Union (TFEU), in particular Article 101.
- Commission Regulation (EU) 2022/720 of 10 May 2022 on the application of Article 101(3) of the Treaty to categories of vertical agreements and concerted practices (VBER).
- Case law of the Court of Justice of the European Union and the French Competition Authority.
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