A competing franchisee on the corner?

A franchisor's duty of care is a hotly debated topic. Consider the franchisor's duty of care with respect to sales projections that are provided. Recently, the franchisor's duty of care has also frequently been discussed in connection with changes in or even termination of the franchise formula intended by the franchisor. Consider the franchisor's decision to convert certain stores or change the conditions attached to the use of the franchise formula. What can franchisees do in that case?

To answer this question, it is worth going back to the basis of the franchise agreement. This is because the extent of the franchisor's duty of care is largely determined by the provisions of the franchise agreement. After all, these set out the reciprocal rights and obligations of the franchisor and the franchisee. The franchisor grants the franchisee the right to use a certain brand or trade name, the formula name, and related elements in return for a certain fee. In order to use that right, the franchisee must meet the conditions set by the franchisor. After all, the franchisor has an interest in uniformity of the franchise formula, which can only be achieved by imposing the same conditions on all franchisees. Against this are the interests of the franchisees, who must make certain investments to operate their branch of the franchise formula. In addition, the franchisor often assumes various obligations, in order to support the franchisees in running their establishment.

Franchise formula changes

The franchisor will need to continue to invest in the franchise formula over the years to ensure that it remains successful. This may result in the need for drastic changes, with which franchisees may not be too happy. For example, franchisor Maxeda recently announced its intention to convert several Formido stores into Praxis stores. A similar case occurred recently at franchisor Intertoys. It was announced by the franchisor in June 2016 that the Bart Smit stores would continue under the Intertoys name and would be converted for that purpose. The conversion of certain stores naturally affects the franchisees of the stores being converted on the one hand, but also the other franchisees in a certain area. The intended conversion of the Bart Smit stores had the effect that in some catchment areas several Intertoys stores would be established, in breach of the exclusivity clause in the franchise agreement. The franchisor negotiated about this with the affected franchisees and tried to obtain required permission. Despite the compensation offered by the franchisor, no agreement was reached with all franchisees. Because the franchisor decided to go ahead with its plans even without the franchisees' consent, several franchisees in proceedings sought, among other things, an injunction for the franchisor to convert the Bart Smit stores in question. Intertoys did not find the franchisees' objections justified, as it was precisely investing in the Intertoys formula through the reorganization, in the interests of the franchisees.

The court ruled that in principle a franchisor can be required not to violate the exclusivity clause contained in the franchise agreement. After all, the value of the franchise agreement is mainly determined by the exclusivity clause. Among other things, the exclusivity clause enables the franchisee to recoup the investments made. According to the court, the exclusivity clause in this case requires the franchisor to obtain permission from the franchisee to convert the stores. That it would be necessary to proceed with the conversion in order to maintain a viable formula is insufficient to be allowed to violate the exclusivity clause. This could be different if the franchisor had sufficiently demonstrated the business necessity of the restructuring. Such a business necessity could under circumstances mean that a franchisee cannot withhold the required consent according to standards of reasonableness and fairness.

Furthermore, the franchise agreement may contain specific cases in which the franchisee may not withhold its consent. That had not happened in this case. In principle, the franchisee is then free to withhold his consent on the basis of arguments that are important to him. This certainly applies if the arguments are understandable from his economic position as a franchisee. This may include the argument that the compensation offered by the franchisor is not high enough, provided it is within reasonable limits. Thus, when reasonable compensation is offered by the franchisor, the franchisee can no longer claim lack of consent. In any event, a franchisor will have to consider the interests of all affected franchisees in the context of proposed changes to the franchise formula. In doing so, the franchisor must take seriously the likelihood of harm to the franchisees and its extent. In the previous matter, although Intertoys had proposed a compensation scheme, it was not such that the franchisee should no longer have withheld its consent on that basis.

It follows from the said example that there will always be a trade-off between the franchisor's interests in making changes to the franchise formula and the interests of the franchisees affected by them. It is advisable to regulate as much as possible in the franchise agreement the requirements for implementing changes. Despite a clear regulation in the franchise agreement, this provision may still be set aside if the interests of the franchisor and the franchise formula require it and the interests of the franchisee have been sufficiently considered in the decision-making process. In that case, a franchisee may possibly be required to convert his store. Obviously, agreements will then also have to be made regarding the conversion budget and for whose account it will be.

If the franchisee cannot be obliged to convert his store and he decides not to cooperate, the question may arise to what extent the franchisor is still obliged to continue investing in the "old" franchise formula. This, of course, again depends on what is provided in the franchise agreement in this regard. After all, the franchisor in that case remains obliged to fulfill its obligations under the franchise agreement.

Changes conditions of use franchise formula

In addition to making changes to the franchise formula itself, a franchisor could also decide to impose new conditions on the use of the franchise formula. The question then arises whether the franchisee may continue to use the franchise formula, including the formula name, under the existing terms or whether it may be required to agree to the changed terms. Recently, the question was raised whether the franchisor can terminate the franchise agreement if the franchisee does not want to agree to the new terms. This will require first of all looking at what is provided in the franchise agreement in this regard. In a recent ruling in an issue with a franchisee of snack bar Bram Ladage, the franchise agreement stated that the franchisor was entitled to terminate the agreement if it could not reasonably be required to continue the agreement. The question then becomes how this provision should be interpreted. According to the court, given this provision, the agreement could not be terminated outright, but it had to be assessed whether there was a justifiable ground for terminating the franchise agreement. On the one hand, a franchisee may have a legitimate interest in holding on to certain provisions of the old agreement, but on the other hand it must be cooperative. Therefore, the franchisee will have to specifically state which amended provisions he objects to and why.

Thus, to answer the question whether a particular provision in the franchise agreement, for example an exclusivity clause, can be amended, the interests of both the franchisee and the franchisor must always be considered. Non-cooperation by the franchisee could under circumstances lead to the franchisor no longer being required to maintain the franchise agreement, so that it can be terminated. The mere pursuit of uniformity in all franchise agreements, however, does not in itself justify termination.

If the franchisor has grounds to terminate the franchise agreement, the relationship between the franchisor and the franchisee will have to be settled. This, of course, also applies if the franchisee himself should decide to terminate the agreement. This may affect, for example, the franchisee's debt to the franchisor. Often something will have been stipulated about this in the franchise agreement. When this is not the case, the question is whether the franchisor can claim this debt at once. There will be circumstances under which this is not reasonable. If the termination of the franchise agreement is attributable to the franchisee, however, that in turn more quickly justifies claiming the debt in full.

The franchise formula, including the formula name, is ultimately owned by the franchisor. This means that the franchisor can give direction to the formula and impose requirements on its use by franchisees. It is important for both franchisors and franchisees to clearly define their rights and obligations in the franchise agreement to avoid discussion as much as possible. Franchisees who fail to meet the requirements set by the franchisor or fail to go along with necessary changes may be left empty-handed under circumstances. Indeed, in order to continue using the formula name after the end of the franchise agreement, a transfer of the name by the franchisor would have to take place. However, a franchisor will always have to keep the interests of franchisees in mind when determining the formula's strategy.