The Franchise Act is coming: key changes at a glance

After the House of Representatives unanimously passed the Franchise Bill on June 16, 2020, it was disposed of by the Senate on June 30, 2020 as a hammer piece. This means that the new Franchise Act is imminent. The purpose of the Franchise Act is to make the relationship between franchisors and franchisees more balanced. As a result, many franchise agreements in the retail industry will need to be reviewed and amended. As it looks now, the law will take effect as early as Jan. 1, 2021. In this article, we briefly discuss the most important changes. What will change on January 1, 2021 and what should you as a franchisor or franchisee be aware of?

The new Franchise Act balances four components

The legislature believes that there is currently too much inequality between the franchisor and the franchisee. As a dependent and weaker party, the franchisee too often loses out. According to the legislator, it is therefore important to strengthen the position of the franchisee. To make the relationship between the franchisor and franchisee more balanced, the Franchise Act emphasizes four components that are crucial to balanced franchise relationships. These four components are:

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).

To enshrine these sections in law, a number of changes are being made to Book 7 of the Civil Code (BW), by introducing a new title (Title 16) on the franchise agreement. We continue this article by discussing the new law in outline.

The franchise relationship

Central to the new Franchise Act is that parties conduct themselves as "good franchisors" and "good franchisees. This basic principle covers not only the run-up to the franchise relationship (the so-called pre-contractual phase), but also the franchise relationship as such. Of importance in this relationship is that the parties act toward each other with reasonableness and care. Thus, in addition to its own interests, the franchisor must also take into account the interests of the chain as a whole and the individual interests of the franchisee. Do the interests of franchisor and franchisee clash? Then this basic principle presupposes that the parties engage in discussion and make efforts to reach a mutually satisfactory solution. The franchisee should also adopt a constructive attitude in this respect. After all, he too can be expected to think along in the interests of the franchise chain. The principle of dealing with each other in good franchising and good franchising is partly concretized in the form of more specific information and consultation obligations, about which more below.
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Disclosure

An important purpose of the Franchise Act is to strengthen the franchisee's information position, prior to and during the term of the franchise agreement. To this end, the Franchise Act enumerates various subjects about which the franchisee must at least be timely and specifically informed. However, subjects not included in the enumeration may also be covered if they are important for the execution of the franchise agreement. The franchisee himself also has a duty to inform and must, for example, disclose his financial situation so that the franchisor can assess whether he will be able to make the necessary investments.

An important point concerns the provision of information at the pre-contractual stage. The Franchise Act does not require the provision of expected sales or operating results to the (potential) franchisee. However, the Act does include an obligation to provide historical financial location information to the extent that it should reasonably be available. It is important for the franchisee to be able to consciously access the correct information. In this way, a franchisee should be prevented from agreeing to a franchise agreement of which he cannot sufficiently oversee the content of the obligations included and the risks he may face in his business operations as a franchisee. The Franchise Act therefore provides for a four-week period for deliberation, between the time of receiving all relevant information and the time of concluding the franchise agreement (Article 7:914 of the Civil Code). During that period, the draft franchise agreement may not be amended to the detriment of the franchisee. Also, during those four weeks, prior to the intended signing of the agreement, among other things, no investments or other payments in view of the upcoming franchise relationship may be requested from the franchisee.

Against the franchisor's duty to inform, there is also a duty to investigate on the part of the franchisee (Article 7:915 of the Civil Code). The franchisee is expected to use the so-called standstill for his own investigation, in which he may also engage expert support.

The franchise agreement

In addition to the information disclosure provisions, the Franchise Act contains regulations on two topics that in practice cause many problems: compensation for goodwill upon termination of the franchise relationship and the non-compete clause.

In practice, the situation still sometimes arises where the franchisee is forced to sell his business to the franchisor on very unfavorable terms. The result may then be substantial capital loss or even bankruptcy of the franchisee. To avoid these undesirable consequences, the franchise agreement should provide for compensation of accrued goodwill to the extent that it is reasonably attributable to the franchisee. Note that this provision only applies if the franchisor takes over the franchise agreement for itself or for the purpose of transferring it to a new franchisee.

The Franchise Act also limits the scope of post-contractual non-compete agreements. These types of clauses restrict the franchisee from carrying out certain activities after the end of the franchise relationship. These provisions are now often (too) broadly worded and restrict the franchisee. By introducing the Franchise Act, the effect of such provisions will be limited to what is necessary to protect know-how, to competitive goods or services, to a period of one year after the end of the franchise agreement and the geographical area within which the franchisee was allowed to operate the formula.

Consultation and consent

The Franchise Act also provides for regulations regarding consultation. Various provisions seek to optimize the coordination of activities between franchisor and franchisee. These consultations are also the prelude to consent by franchisees when the franchisor wants to introduce changes in the franchise formula, which has or may have certain financial consequences for the franchisee. The franchisor must have a degree of latitude to act on its own in maintaining and further developing the franchise formula. In some cases, however, policy changes may have significant consequences for the franchisee. From the point of view of good franchising practices, it is therefore only reasonable to enter into discussions with the franchisee(s) in this regard. Predefined thresholds can be used to determine whether the consent of the franchisee(s) is required.

In determining the level of such thresholds, consideration should be given, with due regard for good franchisor and franchisee character, to what latitude the franchisor will reserve for acting on its own to ensure the necessary clout, and above which thresholds prior consultation and consent is reasonably desirable. In cases where consent is required, a case-by-case examination of how any adverse consequences can be mitigated or avoided can be undertaken.

It is then up to the franchisor whether to submit its intention to all franchisees or to a selective group or one franchisee in the context of a pilot. For consent and support, the franchisor may benefit greatly from well-organized consultation of and with its franchisees through, for example, a representation mechanism, especially if consent must be obtained from multiple franchisees. This is possible if, for example, a formal franchisee association has been chosen. In that case, the articles of association may provide that consent of the board of this association is required. Often this assent is linked to a statutory majority that then binds all franchisees affiliated with the association.

Now what?

As noted in the introduction, the Franchise Act may go into effect as early as January 1, 2021. As of that date, franchisors and franchisees will have to comply with the Franchise Act. Franchise agreements will also have to comply with the statutory provisions. For existing franchise agreements, some provisions will be subject to a two-year transition period. These include the provisions on goodwill, the non-compete clause and the consent requirement for changes to the franchise formula. Provisions in existing franchise agreements that deal with these topics must comply with the Franchise Act within two years of its enactment. If they are not? Then the parties will have to sit down and negotiate new agreements that do comply. For new franchise agreements, these must comply fully with the Franchise Act immediately.

Do you have questions about the franchise changes? Or would you like advice on the impact of the changes on your franchise agreement? If so, please contact Valerie Lipman or Joost van Dongen.