The Franchise Law Review: The Competition Law of the European Union
Antitrust law has an uneasy relationship with franchising and there is no homogeneous approach adopted by regulatory authorities around the world. Some, such as the United States, follow the view of the Organisation for Economic Co-operation and Development and adopt a 'rule-of-reason' approach, by which the practical impact of restrictions determines whether or not they are allowed or prohibited by antitrust law. Others, such as the European Union and (now that the United Kingdom has left) its 27 Member States, take a less flexible, politically motivated per se approach and treat certain restrictions, such as retail price maintenance, as forbidden, regardless of their practical impact on competition. Article 101 of the Treaty on the Functioning of the European Union is the EU's antitrust law and prohibits:
all agreements between undertakings, decisions by associations of undertakings and concerted practices which may affect trade between Member States and which have as their object or effect the prevention, restriction or distortion of competition within the common market
This means that franchisors are prohibited from directly or indirectly trying to fix prices, carve up markets or sources of supply and so on. A franchise agreement incorporating such provisions will be void, potentially leading both to the imposition of fines by the regulators and possible claims for damages from aggrieved parties.2
The definitive explanation of how EU antitrust law impacts franchising in the EU can be found in the seminal decision of the European Court of Justice in the case of Pronuptia de Paris GmbH v. Pronuptia De Paris Irmgard Schilligallis.3 This case, which concerned the German franchisee of a French bridal wear business, establishes the principle that a franchisor can impose restrictions on its franchisees if those restrictions are 'indispensable' to protect the franchisor's know-how and to maintain the identity and reputation of the franchise network,4 but not those restrictions that carve up markets between the franchisor and its franchisees or fix retail prices.5
In the wake of the Pronuptia decision by the ECJ, the European Commission gave further clarification as regards how competition law regulates franchising in the EU through its decisions in Pronuptia, Yves Rocher,6 Computerland,7 Servicemaster8 and Charles Jourdan.9
To encourage smaller businesses to participate in cross-border trade within the EU10 the Commission adopted a de minimis exemption,11 which states that only those agreements that have an 'appreciable' effect on trade (i.e., those that have 15 per cent of the relevant market)12 infringe Article 101(1). However, because of the difficulties in defining what amounts to a market, relying upon the de minimis exemption can be rather imprudent for a franchisor.
Recognising this, and in an attempt to further encourage trade between Member States, the Vertical Restraints Block Exemption13 was adopted. This Block Exemption disapplies Article 101(1) to franchise agreements, although franchising is not expressly referred to in the Regulation. The Exemption applies only to those franchisors with a market share of less than 30 per cent and means that franchisors may, inter alia, impose maximum price restrictions, but not minimum price restrictions. 'Hardcore' restrictions, such as exclusivity, price maintenance and restrictions on cross-supply are not permitted and mean that franchise agreements containing such provisions cannot take advantage of the Block Exemption. Non-compete clauses, although not allowed, can be blue-pencilled out of the agreement, so allowing it to take advantage of the Exemption.
The 27 EU Member States have all adopted competition laws that are exact copies of Article 101, and so there is complete homogeneity among them.
II THE EUROPEAN PARLIAMENT COMMITTEE on INTERNAL MARKET AND CONSUMER PROTECTION REPORT ON THE 'LEGAL PERSPECTIVE OF THE REGULATORY FRAMEWORK AND CHALLENGES FOR FRANCHISING IN THE EU'
In September 2016, following a workshop held at the EU Parliament in Brussels, in which a spectrum of stakeholders offered a range of, in some cases rather polemical, ideas on how franchising should be regulated in the EU, the Directorate-General for Internal Policies of the Union issued a report about the way in which the regulation of franchising in the EU might be reconstructed.
The report is not a formal proposal by the Committee on Internal Market and Consumer Protection but is meant to stimulate further discussion among stakeholders. It offers a bold vision of an entirely new supportive regulatory environment for franchising in the EU, from the one of the most creative academic and professional legal minds in international franchising. It is therefore important for those involved in franchising in the EU to be aware of the approach that it is advocating.
III THE ADVANTAGES DELIVERED BY FRANCHISING
The report observes that franchising is a specific, distinct and uniform type of commercial activity with a positive influence in the EU. It stimulates economic activity by improving distribution and increasing competition. It delivers economic advantages to all those involved and consumers, by inter alia, giving businesses increased access to other EU Member State markets. Arguably, with a looming Brexit, franchising has never been more important in terms of its ability to encourage cross-border EU trade.
IV THE DIFFERENT TYPES OF FRANCHISE REGULATION IN THE EU AND ITS DYSFUNCTIONALITY
The report observes that there are two distinct types of franchise regulation in the EU. Those concerned with macroeconomic issues and those concerned with both the way in which franchisors sell their franchises to potential franchisees and the rights of the two parties during the relationship.
Those regulations that focus on the macroeconomic issues are over-concerned with intra-brand issues and fail to appreciate the value that franchising can contribute to the single market, both by enabling small and medium-sized enterprises (SMEs) to expand effectively throughout the EU, and by unleashing entrepreneurism in individual franchisees throughout the EU.
The various EU Member State sales and relationship regulations lack any real uniformity, increasing cost and causing delays for franchisors seeking to roll out across the single market, thereby creating technical barriers to cross-border franchising within the EU.
To further exacerbate the difficulties, the macroeconomic and sales and relationship-focused regulations been developed in an uncoordinated manner, in isolation from each other. This has contributed to the dysfunctionality of franchise regulation in the EU.
Self-regulation of franchising in the EU lacks both homogeneity and a clear, consistent and effective approach to enforcement, in addition to which there is a significant conflict of interest between the interests of individual franchisors and those of franchising as a way of doing business. In any event, nearly 80 per cent of franchise chains in the EU are not members of national franchise associations and therefore not subject to the self-regulatory regime.
The result of this dysfunctional regulation is that franchising is substantially underperforming in the EU. This is evidenced by the fact that 83.5 per cent of franchising's turnover in the EU is concentrated in only 25 per cent of the Member States and constitutes only 1.86 per cent of the EU's GDP, compared with 5.95 per cent of GDP in the United States and 10.83 per cent of GDP in Australia.
This failure of the regulatory environment to recognise the value that franchising can deliver to the EU and to support and promote it as a way of helping SMEs to grow across the EU can only be remedied by re-engineering the regulatory environment in the EU.
V HOW THE DYSFUNCTIONALITY OF EU REGULATION CAN BE RECTIFIED
Franchising could better fulfil its potential in the EU if the regulatory environment is re-engineered in a manner that:
- promotes franchising and market confidence, by underpinning and supporting the commercial advantages that franchising delivers to franchisors, franchisees and the single market;
- ensures pre-contractual hygiene in franchising;
- ensures a balance between the interests of franchisors and franchisees;
- reconciles the priorities and concerns of the two different types of franchise regulation in an appropriate way; and
- is harmonised throughout each EU Member State.
The report suggests that this could best be done by adopting a European legal act (ELA)containing provisions regulating specific issues that would increase market confidence in franchising, ensure pre-contractual hygiene and impose a mandatory taxonomy of rights and obligations. The following approach, using an ELA, is proposed:
- the ELA should be used to bring a homogenous approach to the regulation of franchising in the EU;
- the ELA should enable SMEs to use franchising to better compete with larger corporations through an 'exchange of benefits'; and
- the ELA should promote market confidence in franchising as a way of doing business, ensuring pre-contractual hygiene and ensuring a fair ongoing relationship between franchisors and their franchisees by imposing appropriate rights and obligations on both parties.
VI WHAT LEGAL INSTRUMENT?
The current heterogeneous regulatory environment creates obstacles that prevent franchisors from taking full advantage of the single market. The same problem was encountered in relation to commercial agency and was overcome by the adoption of a directive.
The report suggests that the catalyst for harmonisation should be an ELA containing provisions regulating specific issues.
The report suggests provisions that the EU Commission could include in an ELA to implement these recommendations. The ELA would have the following three main areas of focus.
i Promoting confidence in franchising
The report proposes that franchising should be seen by business, especially SMEs, as offering legal as well as commercial advantages. They should be offered certain benefits in exchange for using franchising and so allowing third parties to operate their own businesses using the franchisor's brand and know-how. Regulations should enable SMEs to use franchising to better compete with larger corporations. This can be achieved through an exchange of benefits.
This means that franchising must be clearly defined and be perceived as offering positive advantages to all involved in it. In other words, regulation should maintain and increase market confidence in franchising as a way of doing business, as it encourages entrepreneurism not only in SMEs that become franchisors, but also in individuals who become franchisees. The following recommendations will achieve this. This is a positive contribution to the single market, franchisors, franchisees and consumers.
This can be achieved by enabling franchisors to require pre-contractual disclosure by franchisees; focusing regulation only where it is required (by excluding fractional franchisees, de minimis franchisees, sophisticated investors, large investors, large franchisees and insiders); and allowing franchisees to compete on a level playing field with corporate chains.
It should establish this by changes to antitrust law, namely allowing franchisors to set the prices their franchisees may charge and restricting franchisee sales over the internet.
These changes will increase market confidence in franchising in the EU and so encourage SMEs and other businesses to adopt it as part of their growth strategy.
Fraud and sharp practice should be regulated by criminal law and not by a franchise-focused ELA.
ii Ensuring pre-contractual hygiene
It is suggested by the report that regulation should also ensure pre-contractual hygiene. That is, it should help ensure that when franchisors and their franchisees enter into a relationship there is as little opportunity as possible for misunderstanding or a mismatch of expectations between them. To achieve this, franchisees should not only be strongly encouraged to take and follow expert advice, they should also understand exactly what they are buying – a blueprint for a business, not a guarantee of success, and an obligation to follow the franchisor's system.
To help ensure pre-contractual hygiene potential franchisees must be given access to appropriate information and equipped to interpret it in an appropriate manner. It is therefore proposed that advisers (particularly lawyers) are required to take short online franchise education courses if they are to advise potential franchisees, and potential franchisees investing more than €20,000 must produce a certificate from their advisers to prove that they have taken such advice.
National franchise associations can play an important part in educating potential franchisees that they have to work hard, follow the format, risk failure and take and follow expert advice from appropriately experienced professionals. They should receive financial support from central government to help ensure their independence.
Pre-contractual disclosure should:
- be given in a set form 15 working days before execution or payment;
- cover details of the identity and experience of the franchisor, the franchise network, the terms of the franchise agreement and any earnings claims;
- be in plain language;
- contain an appropriate risk statement;
- be accompanied by a copy of the franchise agreement in the form in which it is to be executed;
- include a five-day cooling-off period after execution;
- if not complied with, lead to the right for the franchisee to terminate or claim damages within 12 months of the franchisee becoming aware of the non-compliance or 24 months of the date of execution, whichever is the later, if it resulted in defective consent having been given;
- enable the appropriate regulatory authority to rescind the franchise and related agreements, or claim damages;
- allow the regulatory authorities to impose penalties, including disqualification;
- be allowed electronically;
- give rise to personal liability for any individual responsible for the disclosure document being inaccurate; and
- apply to foreign franchisors with no presence in the relevant Member State, who should be under an obligation to disclose relevant information about analogous markets.
To ensure that the legal requirement is always in step with market practice, there should be a regular review of the disclosure law every five years.
Misleading and deceptive behaviour (failing to comply with the pre-contractual disclosure obligations and making any statement that, although literally true, misleads or deceives or is likely to mislead or deceive) should be prohibited.
Registration of documentation on a public register creates a catalogue of problems in those jurisdictions where it is required both in the EU and elsewhere. Indeed, it has been wrongly viewed by some potential franchisees as an endorsement by the regulator of franchise systems – some of which have later proved to be unsuccessful. It is therefore inappropriate, not only because of the practical difficulties it would give rise to in EU Member States, but also because of its lack of cost-effectiveness and lack of impact.
iii Ensuring a fair relationship
The report goes on to state that the ELA should ensure that both franchisor and franchisee act fairly towards each other, reflecting the bargain that they have struck with each other. This can best be done by imposing mandatory terms onto the franchisor–franchisee relationship through the franchise agreement.
The report observes that discussion of these issues are often polemical and driven by the vested interests of individuals rather than higher-level balance. For example, the suggestion that franchisees should be free of any post-term restriction on using the franchisor's know-how is nothing less than theft of the franchisor's property and, if adopted, would constitute 'free-riding', dealing a potentially near-mortal body blow to franchising and the benefits that it delivers to all involved in it.
It is proposed that there must be a quality-based restriction on franchisors that can take advantage of the benefits offered by the regulation. A franchise that has not operated the business format for at least 12 months or that is operating fewer than four outlets will not have to comply with the regulation and cannot enjoy the exchange of benefits.
Consideration of the realities of the franchise relationship and the risks that both franchisor and franchisee accept lead to the following recommendation.
- not challenge the franchisor's intellectual property;
- implement the business format;
- not compete with the franchisor during the term and for a reasonable period thereafter;
- allow the franchisor the right to purchase the franchisee's business on termination;
- allow termination for cause without compensation;
- allow the franchisor a pre-emptive right of purchase;
- impose a duty of confidentiality; and
- purchase core goods and services from the franchisor or its nominated suppliers.
The franchisor must:
- be the owner of or have the right to license the intellectual property rights on which the franchise is based;
- provide a reasonable level of training;
- refrain from encroachment;
- allow the franchisee the right to sell its business (subject to the franchisor's pre-emptive right); and
- not supply goods or services to the franchisee at overinflated prices or that are unfit for purpose.
Each of these can be justified in their own right, the report states, but would require more space than is available in this chapter.
To take account of the franchise agreement's long-term and changing nature, unconscionable behaviour by both parties must be prohibited.
This report written by Dr Mark Abell on behalf of the Committee on Internal Market and Consumer Protection breaks new ground and proposes that to actively support and encourage franchising within the EU, an ELA should be adopted that aims to:
- define franchising;
- require disclosure by both franchisors and franchisees;
- disapply other duties of care and consumer rights;
- allow franchisors to set retail prices and control use of the internet;
- prohibit unconscionable behaviour;
- impose a specific and exclusive duty of good faith;
- support, and establish a clear role for, national franchise associations; and
- periodically review the terms of the ELA.
These proposals as to how regulation can be used to promote the interests of franchisors, franchisees and consumers in the European Community in a harmonised and constructive manner amount to a step change in the regulation of franchising in the EU and will no doubt receive serious consideration from all those with an interest in franchising within the EU and beyond.
1 Mark Abell is a partner at Bird & Bird LLP.
2 Case C-453/99 Courage Ltd v. Bernard Crehan  QB,  All ER (EC) 886.
3 Case 161/84 Pronuptia de Paris GmbH v. Pronuptia De Paris Irmgard Schillgallis  ECR 353,  1 CMLR 414.
4 id., paragraphs 16, 17.
5 id., paragraph 12(c).
6 Case C-126/91 Schutzverband Gegen Unwesen in der Wirtschaft v. Yves Rocher GmbH  ECR-I-2361.
7 Computerland Europe SA Franchise Agreements, Re, Case IV/32.034,  4 CMLR 259.
8 Servicemaster, OJ  L332/38,  4 CMLR 581.
9 Charles Jourdan, OJ  L35/31,  4 CMLR 591.
10 The de minimis principle was first introduced by the ECJ in the case of Völk v. Ėtablissements Vervaecke Sprl, Case 5/69  ECR 295.
11 Notice on agreements of minor importance that do not fall within the meaning of Article 85(1) of the Treaty establishing the European Community OJ  C 372/13.
12 Commission Notice (EC) on agreements of minor importance that do not appreciably restrict competition under Article 81(1) of the Treaty Establishing the European Community (de minimis) OJ (2001/C 368/07).
13 Commission Regulation (EC) No. 330/2010 on the application of Article 101(3) of the Treaty on the Functioning of the European Union to categories of vertical agreements and concerted practices OJ L 18.104.22.1680 pp. 1–7.