The Lifecycle of Franchise and Distribution Agreements in Europe – Part 1

This series is aimed predominantly at companies negotiating and managing English law contracts in an international context. Whilst English law is a very common choice of governing law, it is important to understand the local legal landscape and whether mandatory local laws will likely conflict with and prevail over the English law position adopted in the contract.

By way of background, common law jurisdictions primarily develop through jurisprudence and adapt as the courts set new precedents. In contrast, civil law jurisdictions are known for having codified statutes and codes which are prioritised over court rulings. Civil law jurisdictions often use an inquisitorial system, where the judge plays an active role in investigating the facts of the case, unlike the adversarial system used in common law. Civil law franchise or distribution agreements tend to be shorter than their common law counterparts (due to the reliance on codified principles), but with the increase in international trade, they are becoming more detailed and starting to look more like their common law cousins. Civil law is the most widespread legal system in the world, adopted in various forms by about 150 countries, including most of Europe however English law, which follows the common law tradition, remains one of the leading jurisdictions for franchising and distribution agreements. The Republic of Ireland is the only other common law system in Europe.

In this first article, we focus on the key differences in relation to pre-contractual issues, including disclosure requirements and a party's ability to withdraw from negotiations.

I. Divergence between common law and civil law approaches to disclosure obligations

A. Buyer beware as the default UK position

The common law approach to pre-contractual discussions is "buyer beware" – this means that the onus is on the franchisee or distributor to ask the right questions and do their due diligence on the business before entering into the agreement. Although many franchisors and principals will provide information to prospective franchisees/distributors, there is no strict legal duty to do so. It is worth noting however that the British Franchise Association imposes a disclosure requirement on its members, and we advise our UK franchise clients to make a uniform disclosure as best practice. This disclosure document can then be built on for international deals. There are limited exceptions to "buyer beware" which should be borne in mind, such as in relation to promissory estoppel and misrepresentation, but we do not explore those exceptions within this article.

B. Codified disclosure obligations in civil law jurisdictions

In many European jurisdictions, there are general disclosure obligations, as well as, or instead of, disclosure requirements that are specific to franchising. For example, in Germany, although there is no franchise specific disclosure obligation, the general principle of culpa in contrahendo[1] is applied in commercial relationships and will also apply in a franchising context. This means that the brand owner should provide its franchisees/distributors with information relating to "all matters which would be required to comply with good faith." The amount of information that is deemed appropriate depends on the experience of the franchise/distributor, but particular attention should be paid to information held only by the brand owner that may significantly impact the franchisee/distributor's decision to enter into the franchise/distribution agreement (German courts have ruled that franchisors in particular must disclose such information.) Whilst there is no mandatory form for disclosure in Germany, the information identified by German case law and the guidelines published by the German Franchise Association provide a helpful (albeit non-binding) list of elements to include in a disclosure document.

In contrast, Italy has specific franchising legislation which requires a franchisor to issue a Franchise Disclosure Document to the proposed franchisee at least 30 days before the franchise agreement is signed.[2] A similar position is found in other jurisdictions such as Belgium and France. France has a similar law but which also requires a local market assessment study as part of disclosure, which is not a requirement in other jurisdictions.

In many jurisdictions including France, Germany, Italy, Belgium, the Netherlands and Spain, disclosure is an ongoing obligation – in such cases, the disclosure process may need to be repeated even where contracting with the same entity, for example, where there are changes to the position of the franchisor or at renewal.

II. The varying ability of parties to withdraw from negotiations

A. Freedom to negotiate without restriction under common law

Under English common law, there is freedom to negotiate without restriction. Generally, a party can break off negotiations for any reason, at any point, without liability. However, parties may establish guardrails around negotiations by agreeing on a short-form non-binding commercial Heads of Terms ("HoTs") (also commonly referred to as a Memorandum of Understating or a Letter of Intent). These HoTs might include some limited binding elements such as confidentiality, exclusivity, choice of law over disputes arising under the HoTs and a deposit payment. However, care should be taken when drafting HoTs as the more binding terms that are added, the greater the risk that the HoTs as a whole could be binding on parties without entering into a long-form agreement. This is particularly a concern where a party starts performance of the terms within the HoTs before the long-form agreement is concluded.

B. The civil law concept of good faith and its impact on negotiations 

The default position in civil law jurisdictions tends to be culpa contrahendo (i.e. "fault in conclusion of a contract") which provides a duty to contract with care. In France, Netherlands, Belgium, Spain and Germany, failure to act in "good faith" can give rise to pre-contractual civil liability. Examples of what constitutes not acting in good faith can include deliberately prolonging negotiations with one party to obtain more favourable terms with another party or breaking off negotiations at an advanced stage with no good cause, particularly if the other party has started making investments.

Moreover, in some jurisdictions with disclosure laws, there are "cooling off" periods which apply in the context of franchising and distribution, allowing the franchisee or distributor to withdraw within a limited time after signing without liability – similar to a consumer's right to withdraw under distance selling regulations.

Concluding thoughts and practical advice

• While parties may agree on English law contracts, they should be mindful that mandatory local law requirements could apply which override the contractual position – e.g. disclosure requirements apply whatever governing law you use.
• Parties should identify any disclosure requirements on a jurisdiction-by-jurisdiction basis and address them with the support of specialist local counsel to ensure that you continue to comply with the relevant obligations. Developing a template disclosure document which can be adapted to a country's specific requirement (via a supplemental addendum) is a cost effective way of managing this process.
• A set of clear HoTs is a good method to clarify intentions and reduce risk during negotiations, but these should be drafted carefully.

If you would like more information on this topic, please contact Gordon Drakes or Rachel Bowley.

This article was co-authored by trainee Melissa Couvet.