The Franchise Law Blog – Tenth Edition

UNITED KINGDOM – LEGAL DEVELOPMENTS

 Domino’s Pizza

Domino’s was, until recently, the “darling” of the UK fast food sector. Its franchisees’ profits were increasing, outlets were being opened at regular intervals and there was so much competition to become a Domino’s Pizza franchisee that generally franchises were only offered to existing successful franchisees. Recent bad publicity may, however, have changed all of that.

A group of franchisees has written to the board of Domino’s threatening to “declare war” if they do not receive a fair share of the profits.

The issue highlights a common problem in franchising namely that if franchisees are required to purchase products from the franchisor or its nominated suppliers, franchisees very often have no protection against the franchisor simply increasing its profit margin on the price of those products. In our view all properly drafted franchise agreements should limit in some way a franchisor’s ability to increase its profits at the expense of franchisees’ profitability.

Can franchisors enforce penalty clauses?

In GPP Bigfield LLP v Solar EPC Solutions the judge applied the new approach to penalty clauses so that only clauses which impose an “exorbitant or unconscionable” consequence to a breach of contract will be struck down. Previously, if a clause specifying that damages had to be paid did not represent a genuine pre-estimate of the party’s loss then it would be treated as a penalty clause provided that the clause applied on a breach of contract.

In the GPP case the court had to consider a liquidated damages clause in respect of delay which did not exclude a force majeure event – an unforeseen event that is beyond the control of either party – giving rise to damages as calculated by the clause. Here the court found that the sum provided in the relevant clause was indeed a genuine pre-estimate of the loss which the innocent party would suffer from the breach and it was not unconscionable to uphold the innocent party’s legitimate interest in ensuring timely performance.

By virtue of the historic approach to penalty clauses few UK franchise agreements contained liquidated damages clauses because if they tried to impose on a franchisee a greater liability to pay damages than would be the case at common law, they would have been unenforceable penalties, but that may now have changed.

Prohibition on use of the internet

It is well known amongst franchise lawyers that franchisors cannot, however much they may want to do so, prevent franchisees from having their own website, but that is precisely what the golf club manufacturer, Ping Europe Limited did in relation to its distributors. Ping argued that selling golf clubs on the internet would be inappropriate because golf clubs needed to be “fitted” to customers. The Competition and Markets Authority rejected Ping’s argument and held that the restriction was a breach of Chapter 1 of the Competition Act 1998 and Article 101 of the Treaty on the Functioning of the European Union. Even though the prohibition related to only two UK retailers, a fine substantially exceeding £1 million, was imposed. Ping appealed to the Competition Appeal Tribunal but the appeal was dismissed with the fine being reduced slightly.

In a subsequent European Commission decision Guess was fined just under €40 million (reduced from €80 million because of their cooperation) for a similar offence with others, which the Commission found had an effect on trade between Member States.

What is the effect of entire agreement clauses?

In NF Football Investments Ltd v NF CC Group Holdings Ltd the High Court had to interpret an entire agreement clause, a clause found in all franchise agreements. It consisted not only of a statement that the agreement represented the entire agreement between the parties but also wording negating reliance or excluding liability in respect of misrepresentations. In previous cases the courts concluded that entire agreement clauses only addressed collateral contracts and not misrepresentations. Nevertheless, the Judge, in this case, found the parties had indeed intended to exclude misrepresentation claims because:-

–        the party against whom the entire agreement clause was being enforced had agreed to indemnify the other party for losses including misrepresentations; and

–        the scope of the matters “extinguished” by the entire agreement clause was very wide and included contracts and non contractual matters such as “negotiations”, “assurances” and “representations”.

Previously the courts had made it clear that if you want to exclude claims for a misrepresentation, then clear words were needed to exclude or limit liability for misrepresentation. It is likely that this decision is based heavily on the facts of the case and franchisors and their lawyers should continue to ensure that they draft franchise agreements with separate clauses protecting franchisors from collateral contracts varying the terms of the franchise agreement had been entered into (entire agreement clauses) and clauses seeking to protect franchisors from misrepresentation claims.

Bringing a fraudulent misrepresentation claim

In Playboy Club v Banca Nazionale del Lavoro Spa the court had to consider a situation where the Playboy Club had previously brought a claim for negligent misrepresentation. It could, but decided not to, have included a fraudulent misrepresentation claim. The court concluded that it would have been a “relatively weak” claim based on the evidence that was then available but during cross examination in the initial trial and after the trial, new material came to light which substantially strengthened the Club’s arguments concerning fraudulent misrepresentation. Accordingly the Court of Appeal held that bringing the second claim, in relation to fraudulent representation, was not an abuse of process – a rule that essentially prevents parties in litigation from taking up more of the court’s time than is strictly necessary.

The judgment is helpful because it repeated a clear warning of the dangers of pleading a speculative fraud claim. Lord Justice Sales said, “courts regard it as improper and can react very adversely, where speculative claims in fraud are banded about by a party to litigation without a solid foundation in the evidence. A party risks the loss of its fund of goodwill and confidence on the part of the court if it makes an allegation of fraud which the court regards as unjustified, and this may affect the court’s reaction to other parts of its case”.

This is particularly important in a franchising context where franchisees’ lawyers generally have to overcome the exclusion of liability for misrepresentation contained in franchise agreements. These exclusions cannot protect franchisors from claims relating to fraudulent misrepresentations. As such, a franchisee’s lawyer can generally only overcome that exclusion of liability by arguing that the franchisor’s misrepresentations were fraudulent.

Does a franchisor have complete discretion?

Franchise agreements often give franchisors complete discretion in some areas – for instance the terms of renewal agreements. When this arises the courts have generally been willing to imply into the agreement a term which limits parties exercising their discretion using various formulae. Nevertheless, in UBS AG v Rose Capital Ventures Limited, which related to a loan agreement that gave a mortgagee an absolute discretion to require repayment on three months notice, the High Court found that that provision was not subject to an implied term that it be exercised “rationally” in accordance with the principles laid down in Braganza v BP Shipping Limited. The court held that because a duty of good faith arose by reason of the mortgagor/mortgagee relationship, this pointed against the possibility of a Braganza clause being applied in relation to a core contractual provision.

The court held that the types of contractual provisions amenable to the implication of a Braganza clause were decisions that affected the rights of both parties to the contract where the decision maker had a clear conflict of interest. Further, the nature of the contractual relationship, including the balance of power between the parties, was a factor to be taken into account.

Currently, it is by no means clear, notwithstanding the efforts of Lord Justice Leggatt, whether a good faith obligation will be implied into franchise agreements and, of course, it is undisputed that the balance of power is in favour of franchisors rather than franchisees. Accordingly, it may well be that a clause will be implied into franchise agreements requiring franchisors to exercise their discretion “rationally” or using a different formulation “in good faith and not arbitrarily or capriciously”.

Oral modifications

Most franchise agreements contain a clause setting out how modifications to the franchise agreement can be made. Those clauses usually prevent oral modifications.

The courts in Australia, Canada and in many States of the United States have held that “no oral modification” clauses were unenforceable but in Rock Advertising Ltd v MWB Business Exchange Centres Ltd, the UK’s Supreme Court unanimously rejected this approach.

Lord Sumption gave the majority opinion that such clauses should generally be enforceable because “the parties to such a clause have agreed … that oral variations … will be invalid” even though refusing to enforce the clause could override the parties true intentions. This emphasises the importance of ensuring that any agreed modification to a franchise agreement is made strictly in accordance with the requirements of the agreement.

 

COMMERCIAL MATTERS

In an important article on the Forbes Website, the author argues that social franchising can address global social issues. The article highlights that successful social enterprises are a growing phenomenon but they are insufficient to deal with worldwide social problems which make “scale an urgent necessity” and “that is where franchising comes in …”.

Largely unnoticed by mainstream commercial franchising practitioners social franchising represents a significant part of franchising activity in the UK.

 

Franchising and Coffee perks up McDonald’s sales

Although McDonald’s is known for its Big Macs, coffee is playing a central role in its improved trading performance. In the UK, sales increased by 1.2% but operating profits increased by 21.6% thanks largely to higher margins on products such as coffee. Company owned outlets now represent only approximately 20% of the total number of outlets in the UK – the remaining outlets are franchised. Turnover from McDonald’s owned restaurants fell by 5% whilst income from franchised outlets rose by 19.6%. It is difficult to think of a better way of demonstrating the advantages of franchising!

 

New survey of UK franchising

Notwithstanding the challenges of Brexit to the British economy, franchising is continuing to grow. UK franchising turnover is in excess of £17 billion, £2 billion more  than in 2015. 700,000 people are now employed in the franchise sector and the UK has an estimated 48,600 franchise units. Surprisingly one in three UK franchisors also have international operations.

The major growth areas for franchising in the UK remain personal services, hotel and catering although generally retail franchises also show growth, notwithstanding the challenging environment for retail.

Most encouragingly 93% of franchisees claim that they operated profitably with failure rates for franchises remaining very low – less than 1% per year closing due to commercial failure.

Are there any countries where franchising has a lower failure rate? We suspect not, which in our view, supports the British Franchise Association’s opposition to the introduction of franchise laws and commitment to compliance with the European Federation’s Code of Ethics.

 

EUROPEAN UNION – LEGAL DEVELOPMENTS

McDonald’s Lose Trademark Battle

Irish business, Supermac’s, has won a long running battle against McDonald’s to have the use of the Big Mac trademark cancelled across Europe. It submitted a request to the European Union Property Office (EUIPO) to cancel the use of the Big Mac and Mc trademarks that McDonald’s has registered in certain classes on the basis that McDonald’s is engaged in “trademark bullying; registering brand names … which are simply stored away in a war chest to use against future competitors.”

In an important Europe-wide judgment, the EUIPO decided that McDonald’s had not proven genuine use of the Big Mac trademark as a restaurant name – or as a burger – and as a result “the application for revocation is wholly successful and the contested EUTM must be revoked in its entirety. According to Article 62(1) EUTMR, the revocation will take effect from the date of the application for revocation, that is, as of 11/4/2017.”

McDonald’s had previously served Supermacs with a 41 page objection against its plans to use the “Supermac’s” name in Europe, stating that it would “take unfair advantage of the distinctive character and repute” of trademarks previously won by the global restaurant giant and would cause confusion.

 

Updating Vertical Restraints Block Exemption

The European Commission has announced that it intends to update the current block exemption which exempts franchise agreements and other vertical agreements from the prohibition on anti-competitive agreements contained in Article 101 of the Treaty on the Functioning of the European Union.

The purpose of this evaluation is to gather evidence on the functioning of the Vertical Block Exemption Regulation (and the relevant Guidelines) that will allow the Commission to determine whether it should let the Regulation lapse, prolong its duration or revise it in order to take proper account of new market developments since its adoption in 2010, notably the increased importance of online sales and the emergence of new market players such as online platforms.

 

Spanish Franchisor Registry Abolished

A Royal Decree 20/Act 20/2018 of 7 December came into force which modifies Article 62 of the Retail Trade Regulation Act 7/1996 of 15 January which required franchisors to register in the Spanish Franchisors’ Registry. Registration is now no longer required.

 

Dutch Franchise Bill

A bill has been presented which seeks to improve the balance in the relationships between franchisors and franchisees. It sets out rules for the pre-contractual disclosure of information, the amendment of a franchise agreement, termination of franchise cooperation and consultation between the franchisor and its franchisees.

The bill also introduces the concept of “good franchisor” and “good franchisee” which requires both parties to act reasonably towards each other, even before the franchise agreement is entered into.

 


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