The Franchise Law Blog – Seventh Edition

Caspian Pizza Limited v Mr Shah [2017] EWCA Civ 1874, 2017 WL 05632399

The Court of Appeal handed down judgment at the end of November in relation to a dispute between a franchisor and an ex franchisee which highlights the dangers of failing to enter into properly drafted franchise agreements.  The franchisor had started to trade as Caspian Pizza in Birmingham in 1991 and had opened other outlets in the West Midlands. The defendant, Mr Shah opened a Caspian Pizza restaurant in Worcester in 2002 which closed in 2005 and further Caspian Pizza restaurants from 2004 onwards.  Mr Shah’s restaurants were opened with the agreement of the franchisor, although no written franchise agreement was entered into. The franchisor argued that an oral franchise agreement had been entered into which required all goodwill in the trade mark to be transferred to the franchisor.

The franchisor obtained registered trade marks for both the name, “Caspian” and for its logo in 2005 and 2010 respectively.

A dispute arose between the parties and the arrangement between the two, whatever that arrangement may have been, came to an end, but Mr Shah continued to use the Caspian name and logo.  The franchisor brought trade mark infringement proceedings but lost and appealed to the Court of Appeal. The Court of Appeal concluded that Mr Shah had indeed obtained a local goodwill in the Caspian name from 2002 onwards prior to the franchisor registering its trade marks. By virtue of Section 11 of the Trade Mark Act 1994 (“TMA”), a registered trade mark is not infringed by the use in the course of trade in a particular locality of an earlier right which applies only to that locality.  Further, by virtue of Section 5(4) of the TMA, a trade mark shall not be registered if, by a passing off action, the owner of an unregistered trade mark, would be entitled to prevent the use of the trade mark. The Court of Appeal found that in the Worcester area, Mr Shah would indeed have been able to prevent the use of the trade mark, because he had developed his own goodwill in it and the Court of Appeal went on to decide that the Caspian trade mark had been invalidly registered.  A bad day for the franchisor.

The case highlights that in almost all cases franchisors should obtain a registered trade mark before franchising and if they do not, very clear written contractual provisions must be agreed setting out who owns the goodwill in the trade marks and what is to happen following termination.


Withholding Tax on Continuing Fees

On 1 December 2017 the government published a consultation document relating to the tax treatment of royalty payments made to entities which are not resident in the UK.  The context is that the government is proposing to extend withholding tax to royalty payments made to low or no tax jurisdictions.

UK based franchisors, if they operate under master franchise agreements, need to ensure that their master franchise agreement does not contain a grossing up clause so that the foreign franchisor is able to require the UK master franchisee to increase the payment it makes to the foreign franchisor in order to ensure that the foreign franchisor receives the full amount it would have received had no withholding tax been deducted.

Gross up clauses are quite common in master franchise agreements but ideally they should be subject to a positive obligation on the foreign franchisor to obtain a tax credit in respect of the withholding tax and then to pass on the benefit of the tax credit to the UK based master franchisee.  At the same time, going forward, UK based master franchisees need to be wary about entering into arrangements with foreign franchisors whereby any continuing fees are paid in a “tax friendly” jurisdictions whether in respect of the use of the franchisor’s intellectual property or for any other reason.


The European Parliament has not gone away!

By resolution of 12 September 2017 the European Parliament published its views on the need to encourage harmonisation of the franchise model within the European Union and to increase the dissemination of information concerning franchising. The European Parliament seems to be under the impression that franchising is currently underperforming within the European Union although does not provide any evidence for that view.

Specifically, the European Parliament urges Member States to adopt effective measures against unfair trading practices in franchising and believes “that non legislative homogeneous guidelines, reflecting best practices,” should be put in place.


Interserve Construction Limited v Hitachi

The High Court handed down a judgment on 31 October 2017 that demonstrates the uncertainties in litigation, especially litigation that involves the interpretation of contractual provisions.

A construction contract was entered into between Hitachi and Interserve Construction Limited (“ICL”) in which Hitachi could terminate the contract for a number of reasons set out in clause 43.1. Clause 43.1 after listing those reasons set out “then subject to sub cluse 43.1.A … [Hitachi] may forthwith by notice terminate …”. Clause 43.1(a) provided that in relation to three of those reasons Hitachi “… may (at its absolute discretion) notify [ICL] of the default and if [ICL] fails to commence and diligently pursue the rectification of the default within a period of seven (7) Days after receipt of notification [Hitachi] may by notice terminate the employment of [ICL] under the Contract”.

The meaning of the clause seems clear.  Hitachi could terminate the contract for any of the reasons listed in clause 43.1 but in relation to the three reasons to which clause 43.1(a) applies Hitachi could give ICL the opportunity to remedy the breach but was not obliged to do so – that was what Hitachi argued. That was not, however, how the court interpreted the clause.

The court found that Hitachi had to allow ICL to remedy the breach. The court reminded the parties of the rules of construction as set out by the Supreme Court in Wood v Capita and at Rainy Sky.  Applying those rules the court decided that the natural meaning of the words “subject to sub clause 43.1(a)” in clause 43.1 was that the right to terminate is “subject to” or conditioned on clause 43.1(a). This construction was reinforced by the fact that the words “subject to” were used with that meaning elsewhere in the contract, Hitachi’s construction of the words “subject to” meant that the words effectively had no meaning because Hitachi could always and without the need for express words in the contract require rectification of a default.

The clear message here is that franchisors should not assume that what is obvious to “normal people” may be so obvious to lawyers!


Luxury Brands and the Internet

UK and EU competition law requires franchisees to be allowed to sell products/services through the internet because the internet is viewed (rightly or wrongly) as a form of passive selling and whilst franchisees can be prevented from actively looking for customers outside their territory, they cannot be prevented from passive selling which is responding to unsolicited enquiries.

Until now it has been an open question whether, in the case of luxury brands franchisors could prevent franchisees from making use of third party platforms, such as ebay, to sell their luxury products.  The European Court of Justice’s judgment of 6 December 2017 in the Coty case has now settled the issue. The case related to a selective distribution network rather than a franchise network but we do not believe that the European Court would take a different approach in relation to franchising.

Coty claims to sell luxury cosmetics (although my wife does not agree!) and wanted its selective distributors to agree a modification to their existing distribution agreement which imposed restrictions on their use of third party platforms to sell products. One of the distributors refused to agree the amendment and Coty took it to court.

The European Court held that Article 101(1) of the Treaty on the Functioning of the European Union has to be interpreted as not prohibiting a contractual clause which requires selective distributors of luxury goods to preserve the luxury image of those goods and prevents them from using “in a discernible manner third party platforms for the internet sale of the contract goods” provided the clause has the objective of preserving the luxury image of those goods, is not applied in a discriminatory fashion and is proportionate in the light of that objective.

The court also held that the Vertical Restraints Block Exemption has to be interpreted so that a clause that prevents members of a selective distribution system for luxury goods from making use, in a discernible manner, of third party undertakings for internet sales, does not constitute a restriction of customers within the meaning of Article 4(b) or a restriction on passive sales within the meaning of 4(c) and is therefore not prohibited.

It is our view that franchisors of luxury products or services can therefore prevent their franchisees from using ebay and similar third party internet platforms.


For further information about any of the developments set out in this Blog, please contact John Pratt or any member of the Hamilton Pratt team.

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