The new Franchise Act: the termination of franchise cooperation

Earlier, my colleague Valerie Lipman and I wrote about the upcoming changes in the franchise field due to the introduction of the new Franchise Act. As it looks now, the Franchise Act will go into effect as early as January 1, 2021 and will have far-reaching implications for franchisors and franchisees. For a general overview of the changes, please refer to our earlier blog.

In this series, we discuss the most important changes in the franchise area through four sections:
1. The pre-contractual exchange of information

2. The interim amendment of a current franchise agreement

3. The termination of franchise cooperation.

4. The consultation between franchisor and franchisee(s).

Part 3: The termination of the franchise partnership

In this blog, we address the changes in the area of franchise relationship termination, a topic where many issues arise in practice. More specifically, the Franchise Act deals with a substantive regulation concerning the compensation for goodwill upon termination of a franchise relationship and the non-compete clause. The Franchise Act requires the inclusion of a goodwill regulation for the situation where a franchisor takes over a franchisee's formula. In addition, the Franchise Act provides a framework that non-compete agreements must meet in order to be legally valid.
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Compensation for goodwill

Many franchise agreements have clauses requiring the franchisee to sell its business to the franchisor at the end of the term of the agreement. In many cases, such clauses do not take into account the franchisee's position, which means that sales can take place under very unfavorable conditions and, for example, no compensation for goodwill is paid by the franchisor. The consequences for the franchisee can be significant. Consider substantial capital loss or even bankruptcy of the franchisee. The franchisor, on the other hand, is in a luxury position. It can enter into the formula again (under the same conditions) with a new operator, while it can also benefit from what the franchisee has accumulated in the previous years.

The new Franchise Act includes an obligation to provide in the franchise agreement for compensation for accumulated goodwill, to the extent that it is reasonably attributable to the franchisee.

Under the new Section 7:920 of the Civil Code, the franchise agreement must provide:

• How goodwill is determined:
  • Whether goodwill is present in the franchisee's business;
  • If so, what size it is; and
  • To what extent it is attributable to the franchisor.
• In what manner goodwill reasonably attributable to the franchisee upon termination of the franchise agreement will be compensated.

But note that this obligation only applies when a franchisor acquires the franchise business for itself or with a view to transferring it to a new franchisee. If the transaction is between two franchisees, goodwill is part of the acquisition price negotiated between the parties.

Post-contractual non-compete agreements

Many franchise agreements also have non-compete clauses that continue to have their effect after the termination of the agreement. Such clauses should protect the franchisor from using the know-how provided to the franchisee during the franchise relationship. In many cases, however, non-compete clauses are worded much more broadly than necessary. The Franchise Act ensures that the scope of such clauses is limited to what is necessary to protect the know-how, among other things, and relates only to competing goods or services. In addition, non-competition clauses may only cover a period of one year after the end of the franchise agreement and also apply only in the geographic area within which the franchisee was permitted to operate the formula.

Non-compete and goodwill provisions in violation of the foregoing are prohibited and non-jurisdictional (or void). Current franchise agreements should therefore be amended within two years of the introduction of the Franchise Act. New franchise agreements should take the Franchise Act into account immediately.

Do you have questions about the restatement of such provisions or would you like advice regarding possible renegotiation of a new franchise agreement? If so, please contact Valerie Lipman or Joost van Dongen.