Navigating the competition law aspects of franchising

2014 UIA Florence

Corinne Khayat

Franchising and exclusive or selective distribution systems p. 3

Franchising and Internet p. 12

Post-term non-compete obligations and non-reaffiliation clauses p. 19

Preferential and preemption rights p. 37

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Franchising and exclusive or selective distribution systems

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Franchise agreement and Block Exemption

• The Block Exemption Regulation n°330/2010 of 20 April 2010 states that, pursuant to Article 101(3) of the Treaty on the Functioning of the European Union (TFEU), Article 101(1) does not apply to vertical agreements

• However, this exemption shall not apply:

if the market share held by the supplier exceeds 30 % if the market share held by the buyer exceeds 30 % in case of “hardcore restrictions” that lead to the exclusion of the

whole vertical agreement from the scope of application of the Block Exemption Regulation

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Franchising combined with exclusive or selective distribution system

•Franchised products or services are often sold trough exclusive distribution system or selective distribution system

•The guidance provided by the European Commission Guidelines on Vertical Restraints in respect of the different types of vertical restraints on the sale and resale of goods and services within a franchise agreement (such as exclusive distribution, selective distribution etc.) applies also to franchising, it being specified that:

the more important the transfer of know-how, the more likely it is that the vertical restraints fulfil the conditions of Article 101(3) TFEU

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Exclusive distribution and exclusive customer allocation: definition

•In an exclusive distribution system, the supplier agrees to sell its products to only one distributor for resale in a particular territory

•In an exclusive customer allocation system, the supplier agrees to sell its products to only one distributor for resale to a particular group of customers

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Exclusive distribution and exclusive customer allocation: exempted restrictions

• When franchising is combined with these systems, the franchisor may prevent the franchisee from:

actively selling products to a territory or a customer group which has been allocated to another franchisee or which the franchisor has reserved to itself

• “Active” sales means actively approaching individual customers by, for instance, direct mail, including the sending of unsolicited e-mails, or visits, or actively approaching a specific customer group or customers in a specific territory through advertisement in media, on the internet or other promotions specifically targeted at that customer group or at customers in that territory

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Exclusive distribution and exclusive customer allocation: non-exempted hardcore restrictions

• According to the Block Exemption Agreement, “hardcore restrictions” under these systems consist in:

the restriction of passive sales outside the distributor’s exclusive territory or to an exclusive customer group reserved to the supplier or allocated by the supplier to another distributor

• “Passive” sales means responding to unsolicited requests from individual customers including delivery of goods or services to such customers

• For example, see Court of Appeal of Lyon, 7 February 2013, n°11/00774

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Selective distribution: definition

• Selective distribution consists in restricting the number of authorized dealers by applying selection criteria linked to the nature of the product and in restricting sales to non-authorised distributors, leaving only appointed dealers and final customers as possible buyers

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Selective distribution: exempted restrictions

• Under a selective franchise system, the franchisor may prevent the franchisee from:

selling products to unauthorized dealers

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Selective distribution: non-exempted hardcore restrictions

• According to the Block Exemption Agreement, “hardcore restrictions” in a selective distribution system consist in:

the restriction of sales by the members of the selective distribution system to authorised dealers

the restriction of active or passive sales to end users by members of the selective distribution system operating at the retail level of trade

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Franchising and Internet

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Internet: « It is forbidden to forbid »

• In principle, every distributor must be allowed to use the internet to sell products (European Commission Guidelines on Vertical Restraints and French Competition Authority, decision n°08-D-25, 29 October 2008, Pierre Fabre, confirmed on this point by the Court of Appeal of Paris, 31 January 2013, n°2008/23812)

• The use by a franchisee of its own website cannot be compared to the opening of a new outlet in a different location

• According to the French Supreme Court, the opening of a website by the franchisor cannot be considered as the creation of a point of sale within the franchisee’s exclusive territory (Cour de cassation, 10 September 2013, n°12-11.701)

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Internet: unauthorised restrictions • In general, using a website to sell products is considered as a form of

passive selling. Therefore, in principle:

the exclusive franchisee shall not be bound to refuse a sale from customers located in another exclusive territory, who reached the franchisee through its website

within a selective distribution system, the franchisors should be free to sell, both actively ad passively, to all end users with the help of internet

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Internet: unauthorised restrictions

the franchisee shall not pay a higher price for products intended to be resold online than for products intended to be resold offline

the franchisor shall not limit the proportion of overall sales made over the internet

within a selective distribution system, the franchisor shall not impose

any obligations which would dissuade the franchisee from using the internet by using criteria for online sales which are not overall equivalent to the criteria imposed for offline sales

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Internet: authorised restrictions

• However, under a franchise agreement:

within an exclusive distribution system, active selling into other franchisees’ exclusive territories or customer groups through internet (such as using territory-based banners on third party websites or paying online advertisement provider to have advertisements displayed specifically to users in a particular territory) may be restrained

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Internet: authorised restrictions

The franchisor may require quality standards for the use of the internet site to resell its goods, just as the franchisor may require quality standards for a shop and for promotion in general (in particular for selective distribution)

Within a selective distribution system, the criteria imposed for online do not need to be identical to those imposed for offline sales but should pursue the same objectives and achieve comparable results (for example, requirement for a online after-sales help desk)

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Internet: the case of « pure players »

• The franchisor may require that its franchisees have one or more “solid” point of sales, excluding “pure-players” who sell products only via internet

• However, such a restriction may not be exempted if it has negative effects on competition and if it is not justified by the nature of the products (French Competition Authority, opinion n°12-A-20, 18 September 2012 and European Commission Guidelines on Vertical Restraints concerning selective distribution)

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Post-term non-compete obligations and non-reaffiliation clauses

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Post-term non-compete obligations: definition

•A post-term non-compete obligation is defined as any direct or indirect obligation causing the franchisee, after termination of the agreement, not to manufacture, purchase, sell or resell goods or services (Article 5(3) of the Block Exemption Regulation)

•The aim of a post-term non-compete obligation is in principle to preclude the franchisee from using the franchisor’s know-how when entering into another franchise agreement with a competing franchisor or when opening a shop of a similar nature in an area where he may compete with a member of the franchise network

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Post-term non-compete obligations: conditions of validity

• Post-term non-compete obligations can be considered as anti-competitive agreements within the meaning of Article 101(1) TFEU

• However, provisions which are essential in order to avoid that the know-how and assistance provided by the franchisor do not benefit competitors do not constitute restrictions of competition for the purposes of Article 101(1) TFEU (European Court, 28 January 1986, Case 161/84 – Pronuptia)

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Post-term non-compete obligations: conditions of validity

•Therefore a post-term non-compete clause can, under certain circumstances, be seen “… a reasonable compromise between the franchisor’s concern to protect the confidentiality of his business formula and to open a new outlet in the ex-franchisee’s former exclusive territory on the one hand, and the ex-franchisee’s legitimate interest in continuing to operate in the same field in the other hand” (European Commission, 13 July 1987, IV/32.034 – Computerland)

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Post term non compete obligations: conditions of validity

• Post-term non-compete obligation falls outside the scope of Article 101(1) TFEU and is covered by the Block Exemption Regulation (Article 5(3)) if the obligation:

relates to goods or services which compete with the contract goods or services

is indispensable to protect know-how transferred by the franchisor to the franchisee

is limited to the premises and land from which the franchisee has operated during the contract period

is limited to a maximum period of one year after the termination of the agreement

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Post-term non-compete obligations: conditions of validity• Post-term non-compete obligations will not benefit from the automatic

exemption under the Block Exemption Regulation:

when they do meet the conditions set out in Article 5(3) of the Block Exemption Regulation

where the market shares of the franchisor and the franchisee exceed 30%

However, such obligations still can benefit from an individual exemption if the parties to the franchise agreement demonstrate that the conditions of Article 101(3) TFEU are fulfilled

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Post-term non-compete obligations: conditions of validity• The French judges and the French Competition Authority apply the

conditions provided by the Block Exemption Regulation when the non-compete obligation may affect trade between Member States and use these conditions as an analysis guide to assess internal situations

• French case law considers that post-term non-compete obligations are:

inherent to franchising since they ensure the protection of the franchisor‘s know-how and allow the franchisor time to establish a new franchisee in the ex-franchisee’s territory

valid under competition law provided that they meet criteria of necessity and proportionality

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Post-term non-compete obligations: strict definition of know-how• Know-how means the package of non-patented practical information,

resulting from experience and testing by the franchisor, which is secret, substantial and identified (Article 1 of the Block Exemption Regulation):

‘secret’ means that the know-how is not generally known or easily accessible

‘substantial’ means that the know-how is significant and useful for the franchisee for the use, sale or resale of the contract goods or services

‘identified’ means that the know-how is described in a sufficiently comprehensive manner so as to make it possible to verify that it fulfils the criteria of secrecy and substantiality

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Post-term non-compete obligations: limited geographic scope

•The Court of Justice of the European Union has ruled that the words ‘premises and land from which the buyer has operated during the contract period’ used in Article 5(3) of the Block Exemption Regulation refer only to the place from which the contract goods or services are offered for sale and not to the whole of the territory in which those goods and services may be sold under a franchise agreement (Order of the Court, 7 February 2013, Case C-117/12 - La Retoucherie de Manuela)

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Post-term non-reaffiliation clauses under French law: definition

•French case law makes a distinction between:

non-compete obligations, which restrict the franchisee from engaging in any similar business

and non-reaffiliation obligations, which only preclude the franchisee from entering into another franchise agreement with a competing franchisor

•A similar distinction does not exist under EU case law

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Post-term non-reaffiliation clauses under French law: conditions of validity

• However, the French judges have on several occasions subjected post-term non-reaffiliation clauses to the same conditions of validity as those laid down for the post-term non-compete obligations and the post-term non-reaffiliation clauses are now subject to strict scrutiny

• Therefore, post-term non-reaffiliation clauses must remain proportionate to the legitimate interests of the franchisor, in particular to the protection of its know-how and the preservation of the franchise network identity and reputation, and should not be unreasonably broad as regards both duration and geographic extend

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Post-term non-reaffiliation clauses under French law: franchisee’s interests and proportionality

• French case law is protective of the franchisee’s interests and considers that a post-term non-reaffiliation clause is invalid if the ex-franchisee would not be able to maintain a sufficiently competitive offer without the support of a franchise network and if the clause actually prohibits the ex-franchisee from carrying out a similar and profitable activity

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Post-term non-reaffiliation clauses under French law: protection of the franchisor’s legitimate interests

• The French case law tend to adopt a narrow conception of the legitimate interests of the franchisor

• French judges and Competition Authority are hostile to post-term non-reaffiliation obligations which apply only in case of early termination of the agreement because of a breach by the franchisee of its obligations: they consider that the aim of such an obligation is not to protect the legitimate interests of the franchisor but to discourage the franchisees from leaving the franchise network prematurely

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Post-term non-reaffiliation clauses under French law: protection of the franchisor’s legitimate interests

• In recent decisions, French judges and Competition Authority have considered that the franchisors had other means of preventing the franchisee from disclosing the transmitted know-how

• In particular, the following obligations are covered by the Block Exemption Regulation:

an obligation on the franchisee not to disclose to third parties the know-how provided by the franchisor as long as this know-how is not in the public domain

an obligation on the franchisee not to use know-how licensed by the franchisor for purposes other than the exploitation of the franchise

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Post-term non-reaffiliation clauses under French law: notion of know-how

•In several recent decisions, the French judges and Competition Authority have found that post-term non-reaffiliation clauses were invalid because:

of the low level of technicality, specificity and originality of the know-how transmitted by the franchisor (for instance, Court of Appeal of Paris, 11 September 2013, n°11/14380)

the know-how did not fulfil the criteria of secrecy, identifiability and substantiality (for instance, French Competition Authority, opinion n°12-A-15, 9 July 2012)

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Post-term non-reaffiliation clauses under French law: notion of know-how

•In its opinion n°10-A-26 of 7 December 2010 relating to the retail food distribution, the French Competition Authority has distinguished between:

the parts of know-how which could not be protected by a non-reaffiliation clause: (i) know-how which was observable in stores (relating for example to the arrangement of the store) and (ii) know-how which was non observable but common to all the stores of the franchise network, necessary to the activity of the franchisee and an integral part of the franchisee’s experience and professional skills (relating for example to the financial management skills of the franchisee)

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Post-term non-reaffiliation clauses under French law: notion of know-how

the part of know-how which was specific to the franchise and not easily observable by the competitors (for example know-how relating to the promotion policy), which could potentially justify the presence of post-term non-reaffiliation clauses. The Competition Authority underlined the fact that this kind of know-how was relatively limited

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Post-term non-reaffiliation clauses under French law: limitation in time

• In its opinion n°12-A-15, the French Competition Authority has considered that, even if the post term non-reaffiliation clause of one year respected the maximum period provided by Article 5(3) of the Block Exemption Regulation, the duration of the clause still had to be proportionate to the pursued objective. In this particular case, the French Competition Authority found that the duration of the non-reaffiliation clause should not have exceeded the six-month notice period provided by the agreement in case of termination

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Preferential and preemption rights

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Preferential and preemption rights

• Franchise agreement sometimes contain a right of priority (preferential right or preemption right) in favour of the franchisor to acquire the franchisee’s store

• These types of clauses can be considered as anti-competitive since they artificially reduce competition, notably by restricting the possibility for independent stores to be purchased by competing distribution groups (for instance, French Competition Authority, opinion n°10-A-26)

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Preferential and preemption rights

• Under merger control rules, the possession of preferential or preemption rights cannot, in itself, confer control to is beneficiary

• However, in some cases, the French Competition Authority has considered that these rights, combined with other elements such as a minority shareholding, could confer the franchisor a decisive influence over the franchisee (for instance, French Competition Authority, decision n°09-DCC-64, 17 November 2009)

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2014 UIA Florence